What is Forex Money Management?
Forex money management is a set of self-imposed rules successful traders follow to manage their money effectively; minimising losses, maximising profits, and growing their trading account size.
Forex money management is often, and understandably, confused with risk management, as they are similar concepts. Risk management is more about identifying, analysing and quantifying all the risks associated with trading to manage them effectively and, in doing so, protect yourself from the downsides of trading. Money management focuses on saving your money.
An old trading adage helps sum up money management’s purpose “cut your losses short and let your winners run”. In other words, minimise loss, maximise gains and hopefully, by doing so, become a successful, profitable Forex trader.
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Top Tips For Successful Forex Money Management
We know that, especially as a new trader, there is a lot to learn about the Forex markets. Therefore, to make things easier for you, we have compiled a list of our top tips to help you develop a successful system for your Forex money management.
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1. Trade Only What You Can Afford to Lose
- Our first tip, and probably the most important for any trader, is only to trade what you can afford to lose.
- As a beginner trader, you should only deposit what you can afford to deal with into your trading account and no more.
- You might want to set yourself a maximum acceptable loss per month and if you hit that loss, stop trading.
- The idea is that you are only risking the capital that will not drastically change your life if you lose it.
- Do not ever trade with the money you need for essentials; rent, mortgage payments, food, travel to work, etc.
- Forex trading is not a guaranteed money maker. Some people will end their Forex trading career only having made losses. Do not risk what you cannot afford.
2. Quantify Your Risk per Trade
Once you have decided on an amount of money you are happy to trade with, you need to establish how much you will risk per trade and how you will measure this. This will help determine where you will place your stop loss for each transaction.
There are two common ways of quantifying your risk, each with its advantages and disadvantages.
A Fixed Sum
- Some traders set their maximum risk per trade as a fixed monetary amount. For example, a trader may deposit £10,000 into their trading account and establish that they will risk £500 per trade.
- This is a straightforward rule to follow. Regardless of what it is, you know exactly how much you will risk for each trade. If you make ten trades a day, you know without doing much calculation that the maximum you will bet is £5,000.
- The disadvantage of this strategy is that it does not consider any changes in your trading balance. If you go on a series of wins and grow your account substantially but still stick to the same risk per trade, you could be missing out on more significant returns.
- On the other side of things, if you lose a lot of trades but your risk per trade remains £100, you are risking a higher proportion of your account balance, which could lead to your balance depreciating a lot more quickly.
A Fixed Percentage
- The most common approach is to risk a fixed percentage of your account balance on each trade. Therefore, if a trader has an account balance of £10,000 and decides they want to risk 2% of their capital per trade, the first trade would risk £200.
- The benefit of utilising this method is that your risk per trade will fluctuate along with your account balance, unlike having a fixed sum.
- In theory, if it is stuck to, you could never blow your account balance, and when you are on a winning streak, your risk is increased to take advantage of the higher amount of capital at your disposal.
- The disadvantage here is that your risk per trade will get smaller and smaller along with your balance if you sustain a series of losses.
- This means that it will take you longer to make back your capital if you start to win trades.
3. Establish Your Risk to Reward
- Now you know how much you intend to risk per trade, establish how much you aim to profit from that risk and use it to help place a profit for your businesses.
- This choice will be dependent on your strategy and your trading profile, specifically your appetite for risk.
- A risk to reward ratio of 1:1 would mean, for example, that if your maximum acceptable loss is $100, your profit target would also be $100. However, a ratio of 1:3, however, for the same amount of risk would give a target profit of $300.
- It is generally accepted that a risk to reward ratio should be higher than 1:1. This is because if you won three trades in a row and then lost three works in a row, and your risk to reward ratio was 1:1, you would have made a total profit of £0.
- Whereas, if you were trading with a risk to reward ratio of 1:2, and you had three wins followed by three losses, you would still be in profit because your profit was higher than each trade’s losses.
- Take profit and stop loss depicted: Admiral Markets MetaTrader 5 – GBPUSD H1 Chart. Date Range: 6 November 2020 – 11 November 2020. Date Captured: 11 November 2020. Past performance is not necessarily an indication of future performance.
4. Respect Leverage
- Leverage allows Forex traders to open more prominent positions than their capital would otherwise allow. Essentially, the trader borrows money from their broker to open a leveraged position. For example, if a trader has a leverage of 1:20, they could open a place worth £10,000 with just £500 in their account.
- This sounds like a great deal and, if used correctly, it can be incredibly helpful in becoming a profitable trader.
- Because it allows you to access a more prominent position with less money, leverage can amplify a winning trade’s profit.
- However, and this is important, leverage is a double-edged sword. Those magnified profits on winning trades become magnified losses on losing trades. Therefore, it is essential to use leverage with respect and care.
5. Withdraw Profit
- Many traders are guilty of never withdrawing their profit or not doing it regularly enough.
- If you start to make a sizable amount of profit on your trading account – take it out, enjoy it, do something worthwhile with the money.
- As we said at the beginning, part of Forex money management is maximising your profit.
- To do this, you need to look after your profit when there is one. The longer the money sits in your trading account, the more likely you will trade with it and possibly lose it.
6. Final Thoughts
- These five tips for successful Forex money management should stand you in good stead when starting up as a trader.
- Remember to stick to your rules once you have established exactly what they are. For example, you may decide to write down something like the following as part of your overall trading plan:
- I will not risk more than 3% of my account balance on any one trade
- My preferred risk to reward ratio is 1:2 per trade
- My accumulated losses for the week will not exceed £2,000. If I reach this target, I will stop trading for the week
- As with anything in life, the best way to perfect money management and Forex trading are to practise.
- With Admiral Markets, you can do this on a demo account, absolutely free.
7. Trade Risk-Free with an Admiral Markets Demo Account
- A demo account allows new traders, or experienced traders with a new strategy, to trade in a risk-free environment.
- Why rush straight into the live markets and risk your capital when you can practice first with virtual funds? Click the banner below to open a demo account today:
8. About Admiral Markets
- Admiral Markets is a multi-award winning, globally regulated Forex and CFD broker, offering over 8,000 financial instruments via the world’s most popular trading platforms: MetaTrader 4 MetaTrader 5. Start trading today!
- This material does not contain and should not be construed as having investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments.
- Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time.
- Before making any investment decisions, you should seek independent financial advisors’ advice to ensure you understand the risks.
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