If there is one thing that is most important in forex trading, I would vote for money management as the most important. Many new comers in the scene will think that all it takes for them to make money in the forex market, is to have the forex trading system that works. They will enroll themselves to different seminars teaching different kinds of systems, while ignoring the concept of handling money like most businesses do. Though it is true that a good forex trading system is good to have, but making a killing when you are right and minimize the losses when you are wrong, is the hallmark of a great forex trader.
It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong. – George Soros
George Soros said it best that “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” how you make a living in forex trading depends entirely on how much money you win when you are right and how much money you lost when you are wrong. Maximizing profit and minimizing loses are the most important part of forex trading.
So today’s lesson, we will discuss the different kinds of ways in which to manage your money in trading. As a disclaimer, this is how I manage my money and different people have different ways, this is only the way that I have discovered through years of live trading.
Non Negotiable Stop Losses
In a trading system, there should be an amount of money that you should be comfortable to lose on each one trade. And making a FIRM decision before entering the trade is a good practice. You know, businessmen are known for their strong personality, and that is what I want you to engrained unto your head, this is business. You should only be willing to risk “THIS AMOUNT OF MONEY ONLY”. Take it or leave it. Don’t try to adjust the stop loss because you are too unsure. Your decision should have been finalized before entering the trade.
The 2% Rule
Have a rule to only risk a particular amount of money for every trade. For example, the average trader would risk 2% of his capital on each trade only. This way, if he lose, he doesn’t lose his house. Only 2%. If he wins, there is a potential to gain more. But that is not only the beauty of having a fixed amount of risk. If for example, you are in a winning streak, the 2% also increase in value. Which means, your money compounds in every winning streak. Its a powerful concept. Look on the other side, when you have a losing streak, each 2% risk will make you lose less. Its the perfect depiction of “Maximizing profit and minimizing loss”.
Position sizing in forex trading goes hand in hand with its trading strategy. But I think its a good thing to keep in mind and realize that every great forex trading system must incorporate position sizing in its strategy. Position sizing is the accumulation of more position in a particular pair while its still moving in the direction that you like. Position sizing can be maximized if you have a trading system that allows to predict and follow the trend, as they tend to run for a couple of months and years, you have a maximum profit potential to “Add positions” during the course of the year. It compounds. And is powerful.
Its also a double edge sword if there is an abrupt reversal and you think that you are heavily invested in a pair. It will wipe your account. Just be careful and use it at your discretion.
There is a lot of things to learn about money management. And for years that I try to find books about money management for trading, I have only been disappointed. And the challenge here is to find good resources for it. I myself, learned money management by reading financial books about investing. Which is a lot different from trading. But because investing is allocation of capital, the knowledge translate to forex trading beautifully. The idea is to keep learning and read other books about finance. Oh and business books. Not only trading books, but also investing books.
When trading, try to maximize your profit. Try to add positions on your trade if you think the trend will still go in the same direction. Of course, the challenge is knowing if you’re still right. And it will keep you on your toes. And that’s where you’ll learn to think that you might be wrong. Practice adding and minimizing positions if you think the trend is going for and against you. The mantra is “Maximize profit when right, Minimize profit when wrong.”
Good luck and happy trading.