Trading the forex market is inherently risky and brings with it the possibility of losing money anytime you enter a trade. Whilst this is a fact that most traders are fully aware of, it is a curious notion that many traders seem to ignore money management all together, or pay very little attention to it. The fact that most traders lose money in the markets is not really surprising if you consider that most traders also have no money management plans and mostly ignore the fact that they can lose money on any one trade they enter.
Money Management is a crucial element of trading the financial markets especially in times of volatility. It is a defensive concept that keeps you in funds so you can trade another day and underpins profitable performance. Anything can happen at any time in the markets and using a sensible money management technique ensures that the trader will be able to trade again no matter what happens. A major reason that traders will fail even when using a profitable trading system is because the money management they are using simply does not give their system an edge long enough to play out over time.
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. This ultimately ensures a trader can withstand losses within his or her trading system without “running down” the account.
Both proper money management and sound trading system are required for a smooth geometric capital growth. The speed and the smoothness of the account's growth depend on how much you risk per trade and on the trading system's accuracy and the payoff ratio parameters (trading system's mathematical expectation). Apart from the controlling currency fluctuations by setting a fixed percentage of the capital to be risked on any trade, money management system can also reduce currency swings through diversification (splitting your risk capital among unrelated currency pairs/trading systems).
Forex trading system and good money management will protect you from greed and pride (which always demand that you overtrade) when your system generates unusually large number of winning signals in a row. It will also protect you from trader paralysis (inability to open new positions) when your system goes through a losing streak as long as you risk a small fraction of your equity per each trade as is set by your money management, no string of losses can wipe out your trading account.