10 Essential Money Management Rules in Forex Trading
Money management in Forex is one of the most important and yet most ignored topics. Too often we hear and see many trading strategies being advertised all over the place, but very little information out there on money management. Why is money management in Forex so important?
Profitable trading is not all about one or two fluke profit trades. Profitability in Forex is the ability to make Forex trading profits over time, with consistency and regularity. Forex money management is what makes the difference between a winning trader, and one who wakes up in the morning afraid to check his trading platform because he doesn’t know what to expect.
It is possible to have six trades in a month, with three winners and three losers, and still come out on top with profits. It is also possible to win 5 out of six trades, and then have the single losing trade wipe you out and return you to baseline level for the month.
What is at play here? The answer is simple: money management. The intention of this article is to put into your hands, ten essential money management rules so that you can transform your trading habits to make you consistently profitable. Here they are:
Start Your Account with a Reasonable Opening Balance
Let me start by jarring some nerves with my contrarian view on this issue. Many brokers out there will tell you that you can start trading with as little as $200. Some even step all the way down and tell you that $50 can get you on your way. Market makers will tell you this because they know the truth: the chance of that money ending up in their hands is nearly 100%. Good money management practices are usually thrown to the dogs with such an account balance. No trader wants to earn money in cents or in single digit dollars. We all want to walk away with hundreds and thousands of dollars, and so a trader will most likely push his luck by using lot size’s way beyond what is acceptable in order to achieve this target. Save yourself from this temptation, which has afflicted nearly all retail traders by opening your trading account with a reasonable account balance.
Do Not Over-leverage Your Accounts
The allure of Forex trading is in leverage: the ability to control large positions with a small amount of money. Many industry experts do not advocate using more than 1:100 leverages, but we see traders being offered leverages as high as 1:500 for trading. Leverage in Forex is a two-edged sword. It can work in the trader’s favour, or against him. Most of the time leverage works against traders.
Do Not Overtrade
Over trading can mean taking too many trades at a time, thus increasing your risk exposure to the market. It can also mean trying to chase pips all over the market by placing too many trades in a day, especially after a losing run in an attempt to get back some of what was lost. Either way, you run the risk of losing big.
Use Acceptable Risk
No matter how juicy a trade may look, limit your risks so you can live to trade another day. Most experts have stipulated 5% as the maximum exposure your account should have in the market at any given time.
Trade with Stops and Targets
Not using a stop loss or a profit target is pure suicide! In Forex, an overnight event can send an unprotected trade badly into the negative territory. It happened in early 2008 when the Feds cut interest rates in an unscheduled weekend move, and more recently with the SNB and Bank of Japan’s interventions. You would never know what hit you.
Use Trailing Stops
This is a feature that helps a trader to protect and lock-in profits.
Never Take Trades, Which Do Not Deliver Risk-Reward Ratios of at Least 1:2
A risk-reward ratio of 1:2 means your profit target is twice your stop loss. If your trade has a R-R ratio of 1:3, it means that for every winner, you will need to lose an equivalent trade three times to wipe out profits. If you make 600 pips in a trade (with a 200 pip stop loss), you would, then need to lose three trades using the same R-R ratio to cancel the profitable trade. This is why a trader can have two winners and three losers in a month and still make money.
Do Not Trade During Sleep Hours
Trading at hours when you normally sleep disturbs your body rhythm and brain function. You will be more prone to mistakes that affect money management. If you want to know what are the best hours to trade on Forex market, read article:
Aim to Compound Small Profits over Time
Trying to score jackpots in trading is what usually gets traders taken to the cleaners. An approach of compounding small profits for bigger gains much later is the way to go.
Use Matching Instruments for Your Account Size
Trying to trade a currency pair like the USDZAR with a spread of 50 pips and a daily range of 1,000 pips on a $1,000 account is risky; the trading account will not be able to handle the draw-downs.
Money Management really is one of the key elements in Forex trading. You can use the best strategy ever developed, have the best trading plan, be perfectly disciplined but when you don’t use proper money management rules you won’t succeed.
In my early trading years, I blew up multiple accounts to learn how important Forex money management is. So do not repeat my mistakes.
Happy Money Managing!
P.S.: Did I forget an important money management rule? If yes, please let me know by letting a comment. Thank You!