Money Management in Forex Trading (Part I)

Money Management in Forex Trading (Part I)

Many Forex traders start trading live too soon. They don’t have any understanding and learning of good money management rules. As a Forex trader, you need to develop a few good money management rules. Practice them on your demo account before starting live trading. By developing your own money management rules you are comfortable with, method how much of your money you are willing to risk on one single trade. You also need to determine how many contracts per trade your risk tolerance allows?

The important question is how you can enhance your investment results by making small changes to your trading strategies. Proper money management can be the difference between becoming a successful Forex trader in the long run or an unsuccessful one who decimates his/her account in a few weeks.

Have you ever played poker or watched it being played online or on TV! If you have, then you will never see good poker players play all their cards on a single bet. Good poker players know that by risking only a small amount of their money on a single bet, they can win or lose but will nevertheless play the next hand. If they put everything on the table on a single bet, they will have to be 100% sure of winning, an impossible thing. You can never be 100% sure. Life is the game of probabilities.

You must know this that money trading is far more complicated as compared to playing poker. You will be dealing with hundreds and hundreds of variables that can affect the markets. What to talk of only 52 cards. You must understand and implement good money management rules in order to succeed at Forex trading in the long run.

You can fall into many pitfalls while trading. As a trader you should regularly guard against two emotions. Greed and fear! In case you are on a winning streak, you will become greedy. You would want to risk more to make one big win and you would want to strike it high in one or two big trades. This will make you risk more and more of your money on a single big trade.

When you lose a trade, you become afraid to risk enough of your money on the next trade. Fear takes over and impairs your decision making, making you lose confidence in your judgment and decision making. Let’s see how fear and greed can play havoc with your trading.

Let’s assume you have a run of successful trades. You become overconfident. You are not satisfied by risking only 2% of your equity on a single trade. You want to risk more on the trade because the more you have in a trade, the more you will make if you are right. You increase your risk to 5%. You win. You increase it further to 10%. You again win. Now, you finally decide to put 25% of your equity at risk on the next trade. Misfortune strikes, your successful run comes to an end. You lose.

Assume you had a $100,000 trading account. You had foolishly risked 25% or $25,000 on one trade that you desperately wanted to win. Losing $25,000 method you have only $75,000 in your account left. How much you need to make to get back the original balance of $100,000. You need to make $25,000 again to go back to the original balance. It method you will have to make 25,000/75,000= 33%. So you risked 25% but now you need to make 33% to get back your original amount.

Many investors once they lose a trade become desperate and try to risk more to retrieve their original loss. They end up losing more and more and very soon those investors destroy their accounts. Most of them are out of trading forever soon. There are other traders who try to reduce risk already more on making a losing trade; ultimately they lose any opportunity for meaningful growth in their accounts.

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