This is a Guest post by Orbex
Alan Farley, a renowned trader and author of the famous book Master Swing Trader, famously said that “experienced traders control risk, inexperienced traders chase gains”.
The above quote, clichéd as might sound forms one of the fundamental bases of money management in forex trading. Money management, risk management or any other name that it can be called is one of the critical and most basic elements that determine success in trading. Without proper money management in forex trading a trader cannot expect to stay in the game for long.
Money management is nothing but managing your trading capital and the risks that arise out of the positions that your capital is currently exposed to. It is also commonly referred to as risk management and there are many theories that can be applied into how best to manage your money or risked capital when trading.
Most traders often tend to focus on the widely known, hardly used principle of money management. Be it trading only a 1:2 risk/reward trade set ups or implementing the 1% money management rule. However, what most traders fail at is in managing their trades once they are in a position. While it is a good practice to trade only a 1:2 or higher risk/reward set up, traders need to also focus on minimizing the risks on their open positions. Using tools such as trailing stops or positioning the trades based on booking profits at regular intervals, traders have a better chance when they focus on trading at break even rather than leaving risk on the table.
While the above sounds difficult, it is not entirely difficult to implement. Regardless of what trading strategy you use, there is always room to ensure that you could actively manage your existing positions to eventually eliminate risk off your trade before you head on to searching for the next available set up.
Focusing on just one instrument is also a great way for traders to not only gain context of the instrument that they are trading but also allows you to better manage your risk. As a comparison, it is always difficult to manage risk on two separate positions that you might have, say for example if you were trading Oil and AUDCHF. Both these instruments are hardly correlated in any way and in order to manage risk, traders will need to keep an eye not just on the technical levels but also the fundamentals which tends to shift the market bias in an instant. By keeping distraction at bay, money management in forex is easier to follow when focusing on just one instrument at one point in time. Most new traders often end up trading three if not more different currency pairs and it is easy to see in the above context why it often gets difficult to manage risk this way by having varied open positions.
Setting realistic goals is another factor that plays a role in money management in forex trading. Traders often tend to be undercapitalized while aiming for higher returns. The high goals often results in traders taking on undue risks by way of increasing their positions such as trading a mini lot instead of a micro lot or leaving too much of a stop loss or setting a take profit too wide. One of the less repeated facts about money management is that traders need to also get a grip on their trading goals such as the returns they wish to make. The clichéd 1% money management rule that we often get to hear is usually more applicable to a trading equity around $100,000 and not to an undercapitalized $500 trading account. The expected returns also tend to be different. A 2% return on a $100,000 is definitely higher than a 2% return on a $500 trading account.
If you are a struggling trader or one who wants to take their forex trading seriously, then it is important to ensure that you start paying attention to money management in forex. Start by applying the most simplest of the above points such as sticking to just one instrument at a time or ensuring that your returns are relatively modest in comparison to your trading equity. Focus on minimizing risks on your traders and you will start to see profits coming their way.