Money Management on Forex
What is the secret of a successful forex trader? Most likely, a successful trader is someone who considers trading to be a serious job rather than a hobby or a way to get rich quick. There are 3 major segments in this business: trading strategy, psychology and money management.
In this article we would like to focus on money management in Forex trading and discuss some practical recommendations based on the experience of Forex traders.
Money management is a crucial part of Forex trading
Before we continue it should be noted that money management is an important, if not the most important, part of forex trading. But which is more important - forex strategy or money management? Forex beginners seem to think "strategy" and this explains why they spend most of their time searching for the best entry and exit algorithms. However, the answer for professional traders is the opposite: the most important thing in forex trading is money management, as they have already accepted the fact that no strategy will guarantee a consistent and stable income. So before you start trading it makes sense to spend some time developing rules to help you preserve your trading capital.
What does it mean to manage capital in Forex?
So what is money management in forex? It is the science of how we manage our own money, where the golden rule of investing is that not only are we free to invest our own (solely our own) money, but we should also allow ourselves to lose it.
Beginner traders tend to ask, how much money should they put into their trading account as initial capital? There is no common answer - the amount of seed money will be different for everyone. Why? Because no matter how the trader trades he must be prepared for the worst-case scenario, i.e. even if he loses the whole amount, his current lifestyle will not be drastically changed.
Even though a trader can start trading as soon as he has deposited funds into his account, this does not mean that he should immediately start placing positions, even if he thinks that he has the most brilliant forex strategy in his hands.
How to calculate the lot size of a trade?
Let's use the work of a hypothetical trader - N - for an example. Suppose he has $10,000 on deposit. His first task is to determine the lot size or develop a postulate: how much money he can dispose of when making a deal. This is very important for any trader. Another important rule is that we must risk only a certain percentage of our deposit in each transaction. And, as experience of professional traders shows, it is better if this amount will not exceed 2-3 percent.
Suppose N has also decided to limit the transaction risk to 3 per cent of the deposit. The maximum loss that he can take from one unsuccessful deal will be 300 dollars, which on the background of the total deposit of 10,000 will not be a tragedy with the cries of "I'm broke!
The next task is to determine how much lot volume N can trade. Here he should analyze the chart to determine the entry point into the market, as well as the levels of protective orders and expected take profit. And the most important point is the distance between the entry price and the stop loss.
Let's say N defines the distance between the entry price and stop loss as 50 points. In this case he, using a simple formula:
(10000х3) : 100 = 300
(300:50) x 0.1 = 0.6, where
10000 - total amount of the deposit; 3- the chosen percentage of funds involved in the trade; 50 - distance between entry point and protective order placement level
determines that in this case, it can trade 6 minilots (0.6 standard lots). If the trade goes against the trader, N knows that his maximum drawdown is still the same $300, and he still has $9,700 left in his trading account.
Often Forex beginners find such methodology of calculations difficult because they think the process of making "real" money on the currency market will be very slow. Although, just like any other business in the real world, Forex is not a place where you can get rich in a short time. The important aspect here is that amateurs tend to calculate potential profits while professional traders focus on risk and will first determine how much they will lose if the market goes against them.
To conclude, it is worth noting that you should not open more than one trade at a time, on affiliated trading instruments or on the same currency pair, unless it is a question of building up a position after the first order has been moved to the no-loss zone.
Let's say we are considering two currency pairs that are close in dynamics, such as EURUSD and GBPUSD, where the common part is the US dollar. Many traders will trade following their strategy. But in this case they will risk 6% of their trading account. If the dollar goes "wrong", both trades will be unprofitable, traders will lose that 6%. Do you see what the problem is? What can you do about it? Choose only one of these pairs, so as not to risk more than a certain amount of capital.
Although, of course, with experience in Forex trading, the total amount of the deposited funds involved in all trading instruments can be brought up to 10%, but no more. Remember, the main objective of a trader is to preserve one's trading capital.