Money management in Forex Trading
To trade on the Forex markets is to speculate on uncertainty. Serious and professional traders should always incorporate money management strategies into their trading plan to protect their investments. Professional traders use different money management strategies along with their regular trading plan, and if you want to avoid a severe drawdown on your account, you probably will do it too. So, how do you best prepare for uncertainty?
Main article sections:
- Forex Money Management
- Cut losses short, let profits run
- What is Money Management in Forex Trading
- Intermarket correlation
- Compound Your Account
- Be careful with emotions
Forex Money Management
Forex money management tries to balance two things: restricting worst-case scenario losses to an acceptable level and maximising potential profits.
In other words, we are trying to avoid risking so much that you lose everything or are compelled to stop, OR trading so conservatively that most of your money is still in your wallet when you win.
Adequate Forex money management strategies allow you to keep trading through the bad stretches that will inevitably occur. There are many books written on the subject, often involving complicated mathematical analyses. However, the good news is that the best money management strategies can be simple.
As always, to succeed at trading you will need a complete trading plan that will tell you when to enter/exit, which currency pair to trade and how to manage your money.
So Forex money management is vitally important - and should be taken as a part of the complete trading plan. Below is a list of general guidelines that should be incorporated into a trading plan.
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Cut losses short, let profits run
You should always use stop losses in the best possible way by allowing your profits to accumulate when you have a winning position. Traders often use profit stops for this purpose.
The fact is that trading is not about what you want to make, as profits will take care of themselves. It's about what you don't lose that matters
What is Money Management in Forex Trading
Trading currencies involves taking substantial risks and disparate Forex money management techniques, no matter what the system you use. Because of the free-floating currency market, currency trading without any plan has considerably more in common with gambling than investing.
That is why it is crucial to have a proper Forex business plan. That way you won't be gambling, but instead, investing at minimal risk. We are always here to listen to you and assist you.
As a result, putting funds at risk which you cannot afford to lose should never even be considered a professional Forex trading behaviour. This includes money needed for crucial housing expenses such as your mortgage or rent payment, or the weekly costs that are necessary for you or your family's sustenance.
In general, traders perform better by only trading forex with funds known as risk capital.
That amount of money has been predetermined for trading because it is expendable and therefore not needed for the essentials of living.
Intermarket correlation
Currency pairs tend to move in correlation with one another more than other asset types such as stocks. You need to understand the Intermarket connection in order to make better trades. That is, they're strongly correlated either positively or negatively. If you trade the majors, all of your positions are likely to be correlated with one another as most significant pairs are connected to USD. Remember, Forex money management rules need a complete understanding of Intermarket correlation.
Checking both the 'historical' and 'now moment' correlation is important. If you use MetaTrader, then MetaTrader 4's Supreme edition is the right tool for you.
It will make decisions based on your overall account exposure. If you allow high exposure on correlated pairs, your account balance will be heavily affected by the movements of just one or two of them.
Compound Your Account
Compounding describes how numbers, or money, can grow. Compounding is the exponential growth of a sum of money by continuously reinvesting all profits without any withdrawals, so although the profit percentage remains the same, the original amount of money might grow at a rapid rate.
With the power of compounding, in the long run, you will be able to grow your account by a considerable amount! This could be a good Forex money management plan for you!
Be careful with emotions
However, beware of human emotions. As the stakes get higher, you will suffer more from emotions as you realise you are working with much bigger stakes. If you notice that this is happening it means it is time for a "wake up call" and time to step back into reality.
Professional traders recognise this, and they will not let their emotions drown their profits. By applying this advice, and trading money management, you'll be ahead of 95% of the crowd, and you should be able to make consistent profits.
Don't forget that the Forex Holy Grail lies hidden inside you. Hone your money management skills with our free demo account.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.