Money is the focus point when you get into trading but the forex market is even more about money. As the trading instruments are also currencies paired together. Making money as a forex trader is not at all easy for a newbie no matter how much they prepare. There’s a concept of ‘beginner’s luck’ in trading, but luck can run out anytime and then, it will be losses and nothing else. So, you should never be relaxing just because you got some wins in the initial phase. Maintaining the winning streak and staying on the right track is something that not all traders can do when they get lost in the allure of forex trading.
They become greedy and irrational and make poor trading decisions that lead to their downfall even before they rise. Hence, learning about money management is a must to thrive as a forex trader. You won’t be able to survive without this skill. If you haven’t developed this skill yet, it is time to focus on that and this blog can guide you in the right direction.
Let’s begin with the money management steps in the section below:
Start With Capital Protection
We often say and hear that losses are inevitable when you are a trader in the volatile forex market. But the losses should never go over our risk tolerance level. So, capital protection is a step that we cannot skip in money management. We may feel that we have no control over how much we make or lose while placing orders. Because the currency pair prices can move in any direction and it may not always be aligned with our calculations and analysis. Still, we can keep things under control by taking calculated risk and limiting the account drawdown.
The maximum account drawdown will be different for each trader depending on their risk appetite and also the size of their trading account. We can say a drawdown of 30% to 40% is quite normal in forex trading but anything above 50% means that your account is in a dangerous position as you have lost more than half of your trading capital. Now for someone who runs a small account with $100 capital, 50% is just $50. But for a big account with $10000 capital, the loss is more than $5000.
So, the first rule of money management is to preserve your trading capital by limiting the potential losses. A bigger account drawdown is indeed a red flag for a trader as your entire capital can get wiped out if you don’t take steps to control the losses in time. Many traders give up after blowing up their accounts and this happens because they don’t prioritise capital protection through money management. Saving your account from huge losses is an essential component of money management.
Planning For Risk Management
Controlling the potential losses is not an easy task as the market can move in any direction and it is not in the hands of a trader. However, there is one thing that you can control and it is the amount of risk you want for trading. Hence, the second step is planning for risk management. Have you heard of any trader who succeeded without a risk management plan? It is near to impossible right? No matter how good your strategy is, it will give no results if you are not cautious about the risk involved. The reward you expect must overpower the risk in any situation. The potential reward can be calculated with a profit calculator once you enter all the required details, including the lot size.
But you should also calculate the amount of loss that you will encounter if you don’t win the trade. Once you find an ideal trade setup, you need to decide the favorable price for entering the trade and then actively manage the trade position after placing the order. The essence of risk management is not being risk-averse, as is often misinterpreted. It is about embracing the risk in a way that increases your expected profits and optimizes your trading performance. But at the same time, the mission is to minimize the damage if your analysis turns out to be wrong.
Now, this will be different for every trader, as some of us will be fine with losing a thousand bucks at once but some of us can never afford to lose that much as it is not something affordable based on our financial situation or risk profile. So, we need to follow a personalized approach that is in line with our trading goals and risk appetite.
Decide The Risk-Per-Trade
Risk per trade is simply the amount that you won’t mind losing in a single trade but in technical terms. We have to calculate it as the money being used for the trade depending on where you place your stop loss. You need to calculate it as the percentage of the total amount in your trading account. It will be better to keep it to 1% or 2% at max. Anything more than that can put you in a dangerous position.
The risk per trade is dependent on your position sizing which is the lot size of an order. Optimal position sizing is essential for minimising the risk per trade. The potential gains and losses are directly connected to the size of your trade position. Suppose you are not sure about how to calculate the ideal position size based on your account balance and risk percentage. In that case, you can rely on tools like trading calculators for quick calculations of different metrics.
We all know that leverage amplifies the position size magnifying the profits. But it also multiplies the risk and potential losses. Thus, choosing an ideal leverage ratio is important to keep the risk per trade in limit. The possibility of a margin call is there if you lose more in the leveraged trades as the account balance will drop drastically. Hence, we need to be careful with leverage based on our risk tolerance.
Use Stop-Losses
The last but most important step for money management is placing stop-loss orders for every opened trade. Stop loss orders automate the exit of a losing trade based on the amount of loss you can take before closing the trade. The placement of stop loss should be done properly, as the SL being too close to the opening price will lead to sudden exits. Sometimes, the price starts moving in your favor later on and this leads to unwanted losses.
So, you need to keep the SL at a price level that invalidates your analysis and confirms the loss. There are several strategies that you can follow for stop loss placement. You need to select the one that suits your trading style. You can also use trailing stop-loss orders for flexibility.
Those who keep the trade positions open for a longer duration will prefer wider stop losses. For example, the stop loss of a scalper or day trader will be tighter than the stop loss of a swing trader or position trader. So, you need to decide the stop loss level based on your risk appetite.
Conclusion
With that, we have discussed all the steps that you need to take to apply money management in forex trading. It is similar to risk management but the scope is wider as you not only focus on controlling losses but also maximize the potential gains with minimal risk.
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