Forex Money Management
No doubt that you’ve heard that winning in Forex is more to do with the Forex money management strategy you have in place than the particular trading system or method that you use.
Personally, I am of the opinion that they are both equally important parts of the profit equation.
I’ve covered various trading systems and strategies in the past, and I will definitely share more about them in the future, but today I want to talk about money management in Forex trading because it’s so often glossed over by others.
Risk Management In Trading
Typically on forums and discussion boards online, you will find people talking about the 2% rule, which is a very popular Forex risk %, while others prefer to trade in fixed lot sizes.
For the purposes of this discussion, I will assume that you have no clue about money management in Forex trading whatsoever, but I’m confident that even if you are already applying some form of money management that this will give you some fresh new ideas of how to grow your capital more efficiently.
The Fundamentals Of A Sound Forex Money Management Strategy
The objective of any Forex money management strategy is to keep your capital safe first and foremost, and then to grow it at the most efficient way possible.
Most new traders will make the serious mistake of risking almost all of their account on one trade, which flies in the face of this logic. There’s a very good reason why you shouldn’t do this, and it’s that it’s much harder to make up for lost money than we think.
For example, let’s say you start out with a $10,000 account. You risk it all in the first trade, and end up losing 50%, which puts your account balance at $5,000. How much do you need to make in the next trade to break even? That’s right, 100%.
And if you risk it all again in the next trade, and you lose 50% again, all of a sudden you’re down to $2,500 and needing a 400% gain on your next trade to break even.
That’s why it’s so important to focus on protecting your capital first, before thinking about making the big profits.
The Best Forex Money Management Strategy I Know
The best Forex money management strategy I know is the fixed percentage of capital strategy, which is where most people derive the 2% rule from.
Basically, you limit your risk to a fixed percentage of your trading capital on every trade that you make, and as your account balance changes, you adjust your trading size accordingly. This causes you to lose less money on your losing streaks, and gain more money on your winning streaks, leading to optimal account growth and minimal account drawdown.
For example, let’s say with your $10,000 account you risk 2% on each trade.
You lose your first trade, and you’re down to $9,800.
In the next trade, you risk 2% again, which now reduces your risk to $196 on this trade.
The bigger the draw down your account experiences, the less this Forex money management strategy loses, protecting your capital so that you can recover from it easier.
On the flip side, once your trading profits begin to accumulate, you will experience exponential growth of your account as your position sizes increase cumulatively with your account size.
2% Risk Is Not The Rule
Does it have to be 2% though?
Well, it really depends on the risk profile of the trading system or method that you are using. Typically, the point where optimal growth coincides with minimal drawdown is between 1% – 4%. If you are using a system that experiences a lot of losing streaks followed by the occasional big winner (this is typical of most trend following systems) then you should keep it on the low side, ideally between 1% – 2%.
On the other hand, if you have a system that has fairly consistent wins and losses with no long streaks, then you can push the boundaries further with the 3% – 4% end of the scale.
Let’s not forget that if you have a small account, your main goal should be to grow the account. The problem with risking such a small percentage of your capital is that you may never grow your account to any decent size.
I personally “put all my eggs in one basket” and will risk upwards of 10% on a trade depending on a few variables. I don’t recommend that and you will have to find your own comfort of risk.
Don’t worry if this all doesn’t make sense to you right now, the most important thing is to apply some kind of Forex money management strategy to protect your capital while you’re trading, and the profits may come!