A commander can win a battle every once a while by chance, but without adequate logistics, he’s doomed to fail eventually. Similarly, a fortunate forex trader may be profitable now and then with well devised strategies, but without sufficient skills in money management, he’s certain to fail much of his investment in the end.
What is money management? It is the discipline that teaches traders how to manage risk. The placement of take profit/stop loss orders, trade sizes, leverage, capitalization, long term risk/reward evaluation belong to the realm of money management. The good thing about money management is that methods that work are very well established, and it is highly likely that anyone following them rigorously will eventually achieve profitability. The bad thing is that while it is easy to learn about basic money management techniques, it’s not always easy to apply them.
Here we’ll summarize a few of the simpler rules of money management in forex trading.
1. Build your positions gradually: This is the credo of the money management strategies. Always commit to your position gradually. Await the market to confirm your vision. Always be skeptical about everything, yourself included, and never believe an idea unless it has proven in the market. Build your positions step-by-step, as markets confirm your expectations.
2. Keep trade sizes stable and consistent: Trade sizes should be stable, and in the beginner’s case, constant. One of the telltale signs of a novice, being haphazard with trade sizes will ensure the eventual ruin of an account even if the employed scenario is highly effective.
3. Don’t interfere in trade execution, don’t override stop-loss orders: In most cases, a trade should be left to run its course without much interference by the trader. It is a sign of emotional trading that the trader will frequently override and rewrite stop-loss orders in order to avoid realizing losses. That often results in ruin.
4. Keep losses short, let profits run: This perennial maxim of traders tells us to realize losses as early as possible, while being patient with taking profits. This is in fact the exact opposite of the newcomer’s approach. He will cut profits short, and let losses run out of greed and fear. The correct approach ensures a positive risk reward ratio in most trades.
5. Utilize low leverage in most trades: Leverage is a double edged sword for experienced and professional traders, but it’s a single edge blade for the beginner. It will cut your finger if you use it without acquiring sufficient experience in forex, and even if used successfully, the benefits are often temporary and limited n comparison to the potential damage that may be incurred.
Money management is the first half of trading, so if you have any real intention of experiencing forex trading, it is better to begin your education by learning about it. No one wants to trade just to preserve capital, but the simple truth is that without preserving it, it’s impossible to even conceive any kind of profitability. Although money management lacks the exciting aspects of creating a forex strategy, it is the most useful skill that can be acquired by a beginning trader, and the earlier the better, since it takes some time to master it.
Next step: Trading Psychology