Money Management

Money management is the key to succeeding in pretty much any business, and if you become a Forex trader, then you need to treat it as a business.

Money management is the key area where most failed traders have actually failed. Like any business, a Forex trading account needs to be properly capitalized, protected from loss, and must only risk as much as the trader can afford to lose.

Many features of the brokers, however, try to work against these goals. Too many people enter Forex trading because they see how little is needed to start. With proper management, you really do not need a lot, but you will need a lot more than the minimum necessary amount.

Many brokers advertise the high amount of leverage available to traders. This can go as high as 400:1, meaning that for every dollar you put in to a trade, you are actually trading $400 worth of currency. In practice, this means that for $25, you can operate a single $1000 micro lot. At this level, each pip (which represents about 1/100 of one cent) is worth about 10 cents, profit or loss. Starting at $25, you could wipe out your entire account with just a 250 pip loss.

On the plus side, most brokers do something to help protect you. They will not allow you to continue trading if you have less than your required margin, which means if you are trading one micro lot, as soon as your account falls below $25, your trade is closed (referred to as a margin call). This can be beneficial, but can also work against you, but in the worst case, it does prevent you from losing more than what is actually in your account. If you are trading more lots, then you will need more money in your account to keep your trades open.

While it is nice that the brokers do this to prevent traders from losing more than they bargained for, it is in your best interest to develop your own rules to prevent a margin call from ever being a problem. Once you have rules, you also need the discipline to stick with them.

I follow a few simple rules to keep any trade from taking too much away from me.

1) Account funding: I must have at least $500 in my trading account for each micro lot I trade on any given position. This amount is rounded down, so until I am up to $1000 my trades are all one lot trades. This translates to 2:1 leverage if you only trade one pair at a time. I usually have more than one position open, but it still generally translates to less than 20:1 leverage at any given time. Some people would not be comfortable with even this, so it is very safe to increase your personal margin, $1000 per lot, $2000 per lot, whatever you are comfortable with. I strongly advise going below $500 per lot.

2) Stops: A stop is pretty much what it sounds like, the amount against you where you want your trade to stop. Most brokers allow you to set this amount when you set a trade up. It is an automatic signal to the trading system that you are ready to cut your losses and leave. In my time trading, I have never had the system miss one of my stops, but it can happen, so a stop is not absolute protection, but it is very strong. For my system, I keep stops within 2-3% of my account size, so I seldom enter any trade with a stop of more than 150 pips. Doing so would risk too much of my account at once. My stops are usually tighter than that. This prevents a single trade from draining my account too much.

3) Getting out: My trading system has a number of signals that warn me when a trade may be at risk. If too many are triggered, I will exit the trade and take what profits, or even what losses, have accrued. This may mean I only make 20 - 30 pips of a particular trade, it may even mean losing that much sometimes. The good thing is, any profit is profit, the trade is still a winner even if you don't win that much. Futhermore, the losses are much lower than they might be if I waited until the stop hit.

4) Stop Motion: I often move my stops around once a trade has been running. The trick is, the only ever move in one direction, toward the break even point, or toward higher profit. I will never move a stop if it means I will lose more money (or gain less) if the stop is triggered. Once I have decided how much I am willing to lose on a trade, I will not lose more. If I change my mind and choose to risk losing less, I will never settle for moving back to losing more. I will only accept a move that means losing less, or locking in more profits. Doing otherwise has the potential to break the system.

And that's it. Those four rules do a lot to keep me from losing fast, and are a big part of what allow me to make the gains I have.

Make sure money management is a central part of your strategy, and you'll already be ahead of ninety percent of traders.