Welcome to the final lesson; Chapter 10 – Money Management. Well done on coming this far through the course, you should now have a far greater understanding of not only what the Forex Market is but also how to correctly approach your trades.
In this final chapter we will be looking at one of the most important aspects of trading successfully, that is your money management. In other words how are you managing your risk? What percentage of your entire trading account balance, are you willing to risk on any given trade? We will also look at the Reward to Risk ratio, to ensure we are not taking trades that will destroy our account in the long run.
Being a trader is not just about knowing what and when to trade, it’s about having the correct money management plan in place in order to minimise risk and losses. Okay, let’s get started!
What is Forex Money Management?
When most people get started in Forex Trading, they search for a great Trading Strategy that they can start using in order to make their millions. That is not how trading works, the fact of the matter is no matter how great your trading strategy; it is nothing without a solid money management plan attached to it.
Forex Money Management; is how a trader manages their money in comparison to the trade/s they are taking. This is usually summed up in the form of a percentage of the traders account balance, that he/she is willing to risk on a given trade. For example;
“A trader has an account balance of £10,000, he is going to risk 2% on a trade”
In other words, if the the trader was to lose the trade he would lose 2% of his overall trading account balance, so here the trader would lose:
2% of £10,000 = £200.
The traders new account balance would be £10,000 – £200 = £9,800.
So, is a fixed percentage rate the best way to go about managing our money? We will look at this in more detail later on, for now just understand that trading without a solid money management plan, will greatly limit our chances of trading success. As traders we are to protect our capital first and then look to make a profit. Trading successfully means, being able to continue to trade should we lose any given trade, remember that without any money in our trading account balance.. we can not trade.
Forex Traders should understand that losses are simply part and parcel of trading, they can not be avoided. With this in mind, it becomes even more important to ensure that traders have a money management plan in place. If we look at Forex trading as a whole and factor in these possible losses, we should make sure we are using a Profitable Trading Strategy. This allows us to cancel out any amount of losses by joining it with a good money management plan, so that when we allow the trading strategy to play out, ultimately we are profitable and always come out on top.
Problems with using a Fixed Percentage Rate
A fixed percentage rate, is where the trader uses the same percentage risk in all of their trades. On the surface this seems like a great idea as traders are losing less and less if they go on a losing streak, traders will usually look at this method as a means to keep them in the trading game for longer.
Let’s look at what happens if we were to use a fixed percentage rate and we had a run of losses. For this example we will start out with a £10,000 trading account balance and a fixed percentage risk of 2%.
Account Balance: £10,000.
2% of £10,000 = £200.
Loss 1: £10,000 – £200 = £9,800.
Account Balance: £9,800.
2% of £9,800 = £196.
Loss 2: £9,800 – £196 = £9,604.
Account Balance: £9,604.
2% of £9,604 = £192.08.
Loss 3: £9,604 – £192.08 = £9,411.92.
So as you can see the amount lost on individual trades reduces (£200, £196, £192.08), now as we mentioned earlier this seems like a good way to keep us trading for longer, the problem however is that as we go through our losing streak it is getting more and more difficult to get the account back to break-even and start making money.
As we start losing our account balance gets smaller and smaller. As our account balance gets smaller we have to reduce our stake size or PIP size in order to cover the decreasing account balance, the amount that we risk (which is always representative of 2%) gets smaller, but so does the amount we can win as we are now trading with a lower stake/PIP size.
Remember the account balance we started out with was £10,000, our overall account wont actually be in profit until we go above £10,000. If we were to lose 50% of our account balance, we would have £5,000. Now in order to get back to break-even (£10,000), we need to make £5,000 back again, however it is not 50% of our account balance that we need to make up, but rather 100%! As £5,000 is 100% of our account.
Using a Fixed Money Rate
So how shall we manage our money in our Forex Trading career? An alternative method to the fixed percentage rate, is that of the fixed money rate. This is where the same amount of money is risked per trade (e.g. £100 risk per trade), whilst this does mean that if you are in a losing streak; you will be very slightly increasing the percentage amount you are risking per trade, the reason it is more effective in the long run is that you are able to get back to break even, with a lot more ease as you are not significantly reducing your stake/PIP size. Also as your account balance starts growing and you are risking the same amount, your percentage risk will come down as a result over time.
So to conclude, a fixed money rate would be better than a fixed percentage rate as a means of money/risk management in Forex Trading. This of course should only be the case once you have a proven and tested trading strategy that has a consistent rate of success, this will ensure that even if/when you have a losing streak your trading strategy will come out on top over time.
Congratulations! This concludes the FREE Forex Beginner Course, I hope you have found it to be a very useful source of information/education, you have now built a solid foundation of understanding in regards to Forex Trading. If you found the course useful please share it with others by either referring them directly to the site or by sharing the URL link for the course via social media.