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Money management is a crucial aspect when it comes to forex trading, lack of proper money management or even trading without money management is treating trading as a gamble, a major cause of failure among new forex traders.
It's extremely important to understand the concept of money management, also referred to as "risk management", it represents the amount of money you are going to put at risk when entering the market and risk refers to the probability of losing trading capital.
As a trader, the primary goal is to protect trading capital but most only focus on making profits and hereby taking unnecessary risks causing them to burn through a trading account when trades are going the wrong way. Proper money management allows traders to establish systems that will protect their most valuable asset: trading capital because without money, trading game is over.
Money Management Principles
1) Trade with Sufficient Capital
One of the worst blunders that traders can make is attempting to trade without sufficient capital. The trader with limited capital not only will be a worried trader, always looking to minimize losses beyond the point of realistic trading, but he will also frequently be taken out of the trading game before he can realize any sense of success trading the method(s) or patterns.
2) Exercise Discipline
Discipline is probably one of the most overused words in trading education. However, despite the cliche, discipline continues to be the most important behavior one can master to become a profitable trader. Discipline is the ability to plan your work and work your plan.
It’s the ability to give your trade the time to develop without hastily taking yourself out of the market simply because you are uncomfortable with risk. Discipline is also the ability to continue to trade the methods and patterns even after you’ve suffered losses. Do your best to cultivate the degree of discipline required to be a world-class trader.
3) Employ Risk-to-Reward Ratios
The following table shows possible risk-to reward ratios, and the win ratios required to break even in a trading system.
| Risk-to-Reward Ratio (in pips) |
Win Ratio Required to Break Even |
| 40/20 (2 to 1) |
67% |
| 40/40 (1 to 1) |
50% |
| 40/60 (1 to 1.5) |
40% |
| 40/80 (1 to 2) |
33.5% |
| 60/20 (3 to 1) |
75% |
| 60/60 (1 to 1) |
50% |
| 60 /90 (1 to 1.5) |
40% |
| 30/100 (1 to 3.33)* |
33.3% |
*A trader that uses a 30 pip Stop/Loss and 100 pip limit order, needs only to be right 1/3 of the time to go break even.
4) General Money Management Rule: Your risk per trade should never exceed 2% of your total equity
Imagine you own a forex trading system that is 75% profitable which means it wins 75 trades out of 100.
Do you know which 75 out of those 100 trades will be gainers?
No, maybe the first 75 trades will be winners and the remaining 25 losers, or conversely, maybe the first 25 will be losers and the remaining 75 winners.
If for example, your risk/trade is 4% of your total equity and the first 25 trades are losers, your account will be broke before you even can make it back with the remaining 75 winners. You'll need to make another deposit. That's why money management matters!
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Your risk per trade should never exceed 2% of your total equity
By risking only 1% of total account equity, a trader can be wrong 25 times in a row and still have 75 % of his or her equity left. This is still better than being wrong 25 times in a row and losing 100 % of your account, don't you think?
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Some math
| Amount of Trading Equity Lost |
Amount of Return Necessary to Restore to Original Trading Equity Value |
| 25% |
33% |
| 50% |
100% |
| 75% |
400% |
| 90% |
1000% |
Summary
- Trade only small percentage of your total equity, this will keep you trading.
- Deploy risk-to-reward ratio's, the higher the ratio, the less you have to be right.
- Be a disciplined trader and never forget the money management rules.
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