There are two reasons
you need to look at Money management. The
first is determining the amount of risk you are willing
to take in each trade. The second is to use the
position size calculator to determine how many lots you
should buy or sell so you don’t go over your determined
risk amount. Money management is critical in the
long term success of traders.
Money Management
“Cut
your losses short and let your profits run.”
You may be familiar
with this phrase, but you need to really understand
what it means and believe it. This
is one of the most critical rules that you can learn. Your
success depends on following this rule. It is easier
said than done, because it goes against our nature to
do it. This is another one of the changes you
need to make in your personal thought process. Most
people want to take their profits as soon as they make
any money, however, they will hold onto their losses
forever. They are always hoping the price will
come back and, at a minimum, they can break even. This
is a bad way to invest. You need to close your
positions when they are losing and hold your positions
when they are making you money.
“You
will feel more pain from the loss of a dollar than
you will feel happiness from the gain of that same
dollar.”
It is much harder to
take losses than it is to take winners. That is why many investors end up losing
so much money. They can’t or won’t sell their
losers. One of the first things you need to tell
yourself is that it is “ok” to take a loss. If
you can get good at taking losses, you will be much happier
and a more successful investor.
The key is to only lose
a small amount, while making a large amount on your
winning trades. Remember,
most people naturally choose the opposite of what they
should be doing. They are risk takers when losing
and risk adverse when winning. Conversely, successful
traders are risk takers when winning and risk adverse
when losing.
How much should you
risk per trade? That is the
key question with money management. Failure in
the currency market is usually due to poor money management,
not poor understanding of technical indicators. Learn
how to protect your capital and you will be successful
over the long run.
As new traders have
a hot streak, they want to put more and more into each
trade. The problem with this
mentality is when they have a losing trade, they lose
a lot. After they lose, they start trading with
less money until they have some more success. Then, they
begin to put more and more money in each trade, until
they lose again. After doing this several times,
they lose all their trading capital. This up and
down way of managing money is not a successful formula. Consistent
money management is the key.
Rules1: Diversify: Don’t
keep more than 50 percent of your available money in
the currency market at one time. The rest should
be used for other potential investments.
Rule 2: Decide
on Risk Level: How
much are you willing to lose on any one trade. If
you are willing to lose a maximum of $500, then $500
is your risk per trade. Depending on the size of
your account you may choose to risk between one and five
percent per trade. To begin, start with one percent
and build up from there. Remember, this is not
how much you are going to trade; it is how much you are
going to risk. For example, if you are willing
to risk two percent and you have an account size of $10,000,
you would be willing to lose $200 per trade. Now,
if you have a stop loss set at 20 pips, you could buy
one lot. If each lot is worth $10 and you have
a 20 pip stop loss, you would lose your maximum amount
of $200 (20 x $10 = $200).
Risk Formula:
(Account size x risk
%) / Stop loss $ amount = # contracts ($10,000 x 2%)
/ $200 = 1 contract ($200)/$200
= 1 contract
This formula uses a fixed percentage of you account
size which is more effective than investing a fixed dollar
amount.
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