A trader's money management style can be the difference between a loss and a gain. While it is often viewed as unpleasant and even as a burden, this aspect is crucial to Forex trading success over the long term.
Forex money management forces a consistent monitoring of a trader's position and to accept the losses when necessary. Most people do not care for this aspect of trading, but it is very important.
In many cases of large losses, poor money management was the culprit. Everyone wants the $1 billion profit in a single day, but that is a market rarity. Good Forex money management, though, can give a trader much better odds of a large gain than a trader who has little or no money management.
Larry Hite, a very successful day trader and trend follower, advises beginner traders to risk only 1% of their total equity on any trade. At 1%, a loss is very minimal and it is much easier to recoup and rebound.
On an individual trade, the 1% makes little difference and even if the trader is wrong 20 times, he or she will still maintain 80% in equity. This type of Forex money management, however, requires discipline which is often in short supply with many traders.
Money is easy to lose, but not so easy to make back. This attitude of the market is what wise traders must keep in mind to avoid big losses.
For example, a trader invests $100,000 and loses $50,000. This is a 50% loss. However, the percentage that that trader must make in order get back to the original $100,000 is actually 100%. This would mean that there was a 50% drawdown, the percentage of the difference between the peak and trough of an investment.
It is because of this factor that traders who are joining the Forex market for the first time should use their speculative capital (money set aside for trading purposes with a high probability of loss) only.
In deciding how much money to begin trading with, it is advisable to select an amount that can be considered as an acceptable loss. That number, divided by five, allows the trader more trade attempts - and five times to take a loss.
Another effective Forex money management strategy is to establish a high reward to risk ratio.
When there is a potential to make 3 times more than is being risked, or a 3:1 reward/risk ratio, it is a good time to trade. This is a high reward to risk ratio.
When using this strategy, the chance of a profit is much greater than lower reward to risk ratios. This also leaves much more cushion in the event of a loss.
Good Forex money management can take a trader from gambling with his or her money, hoping for a gain, but probably encountering many losses, to successfully trading while maximizing gains and minimizing losses.
It may not be as exciting as other aspects of Forex trading, but for traders who want higher gains, money management is an absolute necessity.
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Date Published :
Jul 3 2007