Forex Money Management Fundamental to Trading Success

It is important to remember that the aim of trading forex is to make money. Therefore irrespective of how good your currency trading strategies are, if you don't have any money management skills, you are not going to succeed in the long term.

Learning how to manage your money is an important lesson that you must be familiar because it will effect your level of trading risk. To reduce the financial risk you are exposed to you must use a stop loss on every trade. Position size and the number of open positions will also effect the amount of your risk. Although brokers may offer 200:1 and 100:1 leverage doesn't mean you are required to use it.

You must also learn how to control yourself on instances that you are profiting and avoid over investing. You must learn when to exit in a losing trade especially when you are about to reach your loss limit. Forex traders with effective money management skills can live through bad trades without losing all of their capital.

Determining your money managment rules will depend on your risk profile, trading capital and financial goals. It's up to you to determine how much you are willing to risk. Conservative traders risk between 1% and 2% of their trading capital in any one trade.

There are various money management techniques that traders can formulate to allocate and protect their trading capital. A simple and common money management method that is widely used is explained as follows:

1. Determine what percentage of your trading capital you are willing to lose in any one trade. For example if you are willing to lose 2% and your trading capital is $25,000 then you will limit your loss to $500 for any one trade.

2. Determine where you will set your stop loss order, this is normally a set price in pips away from your entry point. For example a stop loss of 25 pips is about $250 per regular sized contracts of $100,000

3. Determine how many contracts you will purchase. As from step 2 above you are willing to risk $500 and from step 3 your stop loss is $250, therefore dividing $500 by $250 means you can purchase 2 contracts. With a standard account and with 100:1 leverage, 2 contracts will require $2,000 of margin deposit.
A good money management principle is never to leverage more than 1/5th of your trading capital at any one time. For example, with $25,000 of trading capital, you should never use more than $5000 of your margin deposit at any one time, which is about 5 regular sized contracts.

An important concept of forex money management is the application of the risk/reward ratio. Before you enter a trade, you need to work out how much you intend to make from that trade and how much you are willing to risk. Generally a risk/reward ratio of about 1:1.5 or greater is necessary. For instance, if your risk/reward ratio is 1:3 and you set your stop loss at 25 pips away from your entry point, then your profit target would be 75 pips. As the trade progresses, suppose you are in profit by 25 pips, you could move your stop loss order to the entry point. This ensures you will not lose any money on that trade, you would 'break even' if you were stopped out. You could also move the stop loss order to lock in some profit, for example when you are 25 pips in profit you can move your stop loss to 15 pips above your entry point. This will ensure that you will exit with a 15 pip profit if your stop loss order is triggered. Therefore good forex money management requires monitoring of your open positions and making adjustments to your risk parameters. You must never move your stop loss order except to lock in existing profits

It is important to continually exercise discipline when trading forex. Good traders have taken the time and energy to build up their skills and confidence in the market. A successful forex trader always adheres to their money management rules. Consistent application of effective money management is crucial to surviving in the long term.