Trading the forex market is inherently risky and brings with it the possibility of losing money anytime you enter a trade. Despite the fact that most traders are fully aware of, it’s a curious notion that many traders seem to ignore money management all together, or pay very little attention to it. Anyone serious about trading would do well to incorporate money management techniques to their trading to protect their portfolio.
It’s often said that what sets successful traders apart from those who fail over the long term is their money management skills. Money management can be thought of as the administrative side of trading. The basic aim is to manage risk by limiting market exposure at any given time, to acceptable levels. This is achieved by managing factors such as the amount of capital risked per trade and the total number of open positions.
Money management is the subsystem of the forex trading plan which controls how much you risk when you get an entry signal from your forex trading strategy. One of the best money management methods used by many professional forex traders is to always risk a fixed percentage of your account balance (e.g. 4%) per position. By using this method a trader gradually increases the size of his trades while he is winning and decreases the size of his trades when he is losing.
Many traders convince themselves that “this trade” has to be a winner because it looks so “perfect,” then they risk more than they are comfortable with losing and they “expect” to win on the trade. Even if this works out three or four trades in a row, it’s bound to back-fire eventually. When you eventually hit that losing trade that you’ve risked too much on, it will inevitably cause a snow-ball effect of emotional trading because you will feel an urge to “make back” all the money you just lost.
The key to mastering money management is shifting your attention from the dollar value of your profits and losses to their percentage value of your account balance. Once you have trained yourself to think of your profits and losses exclusively in percentage terms it will be a simple mathematical task to stick to your money management system (e.g. just enter your constraints into the money management calculator and it will give you the number of lots to trade).