Forex trading is a game of probability- nothing is guaranteed. So, certain practices have to be in place to ensure that when your analysis is wrong, the loss is minimal.
We all stumbled upon the forex market euphoric about the potential returns. The risk involved with trading is totally ignored. This is where money management in forex comes in.
There’s a very thin line between gambling and speculation. The difference lies in observing risk management.
Money management is one of the most important aspects of trading. Sadly, most traders don’t pay attention to this because it’s a bit boring.
The goal for any business is to make sure its wins outweigh its losses while protecting its capital. It cannot be avoided; losses will be incurred. The task is to slim these losses down to a tolerable margin.
To achieve this feat called money management in forex, a bunch of things have to be considered and they are:
- Account size.
- Risk per trade.
- Risk to reward ratio (RR).
- Trade management.
- Best time to trade.
- Trading Plan
The size of an account greatly influences your money management strategy. An account size too little will breed certain acts of desperation.
Enormous gains are desired so traders go ahead to overleverage. Ideally, a trader with an account of 100$ should not risk more than 4 dollars per trade. Doing this leaves a margin for error while keeping your emotions at bay.
The truth is, in other reduce losses and manage risks efficiently, you need enormous capital. What is the optimal capital you should be looking at when trading forex? click here to learn more.
Risk Per Trade
Risk in forex refers to a portion of your account on the line for each trade. Each trader has to choose a risk for their every trade.
It has to be ensured that this is an amount you can afford to lose. This is necessary so market psychology is not affected.
I would advise a risk of 3% at most, whatever percentage of risk is settled for, stick by it always.
Risk to Reward Ratio
Before entering each trade, the potential win and loss should be determined. The possible loss is the “risk” while the potential gains are the “reward” for that order.
At least, the risk to reward for every order opened should be 3:1. This way only high-quality trades are taken and losses can be easily covered when things go south. Of course, scalp traders do not have to abide by this rule.
A lot of traders place a stop loss of 30 pips for a gain of 20 pips, this practice is bad. Sooner or later, you’re bound to get burned this way.
A good analogy for this is a coin flip for a possible gain, it’s low probable to guess if it lands either on its head or tail. The risk to reward in this case is 1:1; gambling (obviously).
Experienced forex traders use either fundamental or technical analysis to attain a bias before an order is opened. After this order is placed, it does not stop there. The trade has to be managed to ensure either profit is secured at the right levels or the bias is invalidated.
First thing’s first, a stop loss should be used at all times. As mentioned prior, a consistent risk should be used whilst ensuring a risk to reward of at least 3:1 is maintained and this is why:
For instance, two consecutively losses were taken. On the third trade, a take profit of 1:4 was hit.
A forex trader with consistent risk broke even on the losses up and made a bit more to top it off.
Let’s take a look at a trader who over-leveraged on his first two losses. Due to fear, on the third trade, he reduced his lot size because of fear. The gains, in this case, would not cover up for the loss.
It is so important to have a standard risk in your trading plan. It improves returns and trading psychology as a whole.
Also, on an occasion where three losses are taken in a row, take a break from the charts to clear your head.
Lastly, don’t be greedy, take partials at certain profit levels. Worst case scenario, employ a trailing stop loss.
Best Time To Trade
Keeping the feeling of “FOMO” (fear of missing out) in check will help to avoid losses. As the saying goes, quality over quantity. Remember, you cannot lose money if you don’t trade.
Choose a market session that suits your time zone/ schedule. In the forex market, there are three major market sessions namely; the New York session, the London session, and the Asia session.
During the Asian session, market movements stall bringing forth consolidation. Although XXX/JPY pairs are exempted from this action. It opens from 12:00 AM to 9:00 AM UTC.
On other hand, the London and New York sessions are the best to trade. The majority of traders open and close orders during this period so there’s an influx of liquidity so either of these windows will do just fine.
They open/ close at 7:00 AM-4:00 PM and 1:00 PM-10:00 PM respectively. The period when both of these periods are active is called the overlap and the forex market is most volatile here.
“A trading plan is an organized approach to executing a trading system that you’ve developed based on your market analysis and outlook while factoring in risk management and personal psychology”
It is a set of guidelines or rules that govern your entire thought process before executing a trade, during, and even when to close a trade.
For a trading plan to work, it has to be followed strictly. Also, as refinements to your trading strategy are made, they should reflect in your trading plan as well.
Most traders start their forex journey expecting it to be a get-rich-quick scheme when this is not the case. Technical and fundamental analysis has to be learned first.
In fact, only demo accounts should be traded initially. This way, an accurate trading strategy can be developed. From back-testing repeatedly, certain behaviours of the market will be identified.
More importantly, money management skills that will take your trading to the next level will be developed.
Risk management involves every action a trader takes to manage risk and maximize profits properly. It covers decisions made before an order is placed and while it’s opened.
There are various risk management practices traders adopt. The best one is to avoid overleveraging with respect to your account.
Over leveraging makes trading uneasy, one loss on a pair like XAU/USD could be devastating. Instead, use a consistent risk between the region of 1%-3% of your account size with trades of healthy risk-to-reward ratios.
Summary: Money Management Forex- Practicable Tactics for Success
Money management will not magically multiply your portfolio. Whatever form of analysis is adopted (fundamental/ technical analysis) is the number one priority.
Then, an edge to make the right decisions in the market should be sought; money management.
Simply put, money management comprises various practices that involve ensuring a suitable amount of risk is used, always. Furthermore, it encompasses trade management to guarantee “close” top optimum profits are made.
Also, as with every forex practice, money management has to suit you as a trader/ your trading style. The forex market throws all kinds of complexities, therefore, you must be flexible.