Money Management in Forex Trading

Posted on March 17, 2008
Filed Under Forex Trading |

Forex Trading To be a successful Forex trader, one needs to understand the important of money management. In reality, many traders fail due to poor execution of money management.

In Forex trading, without proper money management is exactly like traveling in a desert without water. Put it bluntly, a trader will not make it without it. For traders, the objective and goal of proper money management system in place is to ensure long term survival in the Forex market. If you can’t survive long enough till your trading system or method prove its worth, you will not succeed in this game.

All Forex newbie must know that they can never risk the whole trading account on one single trade even though their system or methodology has a 95% winning probability. Many traders lose money as they violate this rule by throwing whatever they have in the account on just one trade. For other traders, they continue to trade the same lot or even bigger lots during their drawdown period. Traders must understand that regardless of whatever system of method they use, there bound to be period of losing steak. It is only when you are able to survive such period, that you can make money in Forex Trading in the long term.

Traders who understand money management know that the more money you lose the more difficult to earn it back. Take an illustrative example - if you have a $10,000 trading account and your trade position lose 10%, which is $1,000. Now your account has a balance of $9,000. To recoup your loss, you need to make 11% on your winning trade. However, if you risk 20% on the trade, the balance will be $8,000. Now you will need 25% to recoup back. Now, imagine a trader who risks 50% on a trade, the next winning trade need to make 100% just to cover the loss. Anyway, if a trader who risk 50% on a single trade, it needs just 2 consecutive losses to wipe out the entire trading account.

This is the reason why a trader should never let these kinds of losses to occur. It is only possible if they adhere to a strict money management rule. Professional traders never allow themselves to be such a “never return” position. They always risk a tiny percentage of their equity on a single trade.

There are few method that trader can use to limit their losses. One of the methods is to never trade with more than 2% risk of your total trading account. Even you have a consecutive loss of 5 trades, you will still have 90% of your trading capital intact. To recoup the 11% of losses is definitely much easier than to recoup 20, 30 or 40%. This method of trading will ensure that you will still be around to trade even though you have a short losing steak. Traders must understand that there is no system or method that wins 100% of the time.

As you may know by now, this is how important money management is in Forex Trading. Hence, to be successful in the Forex arena, one must practice some form of money management in order to succeed.

Cheers, Kampai, Proscht^^!!