Money Management for Forex Traders
At first glance, Forex money management seems like the boring cousin of the real fun: the actual trading. But if you plan on making any real gains in Forex trading, you will learn that money management is equally as important as the way you trade. Arguably, the most successful Forex traders are those who apply money management techniques to minimize losses and maintain steady wins.
The first point at which you will need to apply money management when you begin Forex trading is before you actually outlay any money at all. Experienced traders recommend starting small and learning to understand the markets before betting the proverbial farm in the hopes of scoring big in the early days. The most common (and sagest) advice is to never risk more than about 1 per cent of your total equity on any single trade. If you only risk 1 per cent, then you can afford to have your trades go bad 20 consecutive times and you'll still have 80 per cent of your equity remaining. These are great odds, of course, and will ensure that you don't lose before you begin to gain. This philosophy also helps to increase your confidence slowly and steadily.
The second piece of advice comes when a new Forex trader asks how much they should begin their trading with. The most logical (and sometimes overlooked) answer is to only use what you can afford to lose. That way, if all is lost, you haven't lost a roof over your head!
Now there are also ways to prevent damaging losses once you begin trading the Forex markets. They are called stops and there are four different stops that you or your broker can employ to protect your interests.
1. The Equity Stop
This is where you decide in advance what you are prepared to risk on a single trade and you don't allow yourself to risk beyond that percentage; say, 2%. Once you become a seasoned trader, you might like to increase this figure to 5% but keep in mind that if you make ten wrong trades in a row, your account would be depleted by 50%!
Drawback: No allowance is made for positive fluctuations. If you live by your 2% equity stop (or tell your broker to do so) you may miss out on more lucrative gains.
2. The Chart Stop
The trading charts generated by technical analysis can be good indicators of market movements. Traders who are technically-minded and who thrive on the mathematics and probabilities often excel at the chart stop, but also incorporate equity stops into their calculations.
Drawback: By the time the information is available on the charts, and you have a chance to analyze it for your own trades, the market will have moved again and the data may be slightly, or hugely, outdated.
3. The Volatility Stop
Based on the chart stop but more complex, this one uses volatility in lieu of price action to gauge the associated risks. Unless you are an experienced Forex trader, the volatility stop is very difficult to comprehend and best left to your broker. It deals with high versus low volatility of currency pairs and the application of greater or lesser risk accordingly.
Drawback: Not for the faint of heart or the inexperienced.
4. The Margin Stop
Basically the Margin Stop is where you draw "in advance" a line in your trades at a certain point. Say if your account is $2,000, you might set your margin to $500. You trade with the $1,500 but if your losses reach that figure, then you would close your position to avoid losing any more.
Drawback: There is very little about a Margin Stop that's a drawback. It enables you to keep control of your account, even if you are using a broker to operate it for you.
Forex money management is a vital element to trading in the currency markets. Vigilance and patience are needed to ensure your losses are minimized and your gains are steady.