Why Is Forex Money Management So Important?
Tags: Money Management, Forex, Trading, Risk Management, Forex Trading

Why Is Forex Money Management So Important?

Most of traders may have gone over the feeling of losing all of money though the trading strategy was test over a long time with really good results and they might find it the best trading strategy in the world. So they should know that without good forex money management practices they’ll most likely end up in the negative territory. The main difference between a winning and losing trader may be not their trading strategy, but also the way they deal and manage with open positions, unprofitable trades and stop-losses — that is, how strictly they follow the best practices of money management.

Emotions have a big impact on the way we trade as well as the profit or loss we may earn. We often hope that it will turn back to profitable again instead of quickly exiting a losing trade. This mixture of fear and greed is what ultimately separates the bottom line of professional traders from that of amateurs, and its negative impact can be prevented by learning the basics of money management in forex trading.

Each trader should know What is Risk and Money Management in Forex Trading

Risk management in forex trading is a rather broad concept. In essence, forex risk management involves identifying, assessing and prioritizing currency trading risks and then engaging in the use of resources to minimize, control and monitor the chances and/or effect of adverse events, such as trading losses, and to maximize the chances and/or effect of favorable events, such as trading gains. Money management in trading currencies should be a key part of a forex trader’s overall risk management strategy. It refers to a set of rules that help you maximize your profits, minimize your losses and grow your trading account.

Money management for traders often centers on issues such as determining the level of risk tolerance (loss-accepting amount) before entering the order, reasonable stop loss zone, how to change stop loss, take profit , how to partially or completely exit commands, how to insert additional orders into the market … Traders usually focus first on determining how many percentage of the account for each order. Each trader will have a different way of managing capital, formed from knowledge and own trading experience.

The Importance Of Forex Money Management

Since risk leads to the possibility of losing part or all of an investor’s capital when carrying out the investment, risk management will help investors identify risks before conducting transactions, understand in detail how the losses in each case will be, how to minimum and maximum the size of the investment, the time of investment, the time to end the investment and as well as many other related factors.

For individual forex investors or traders, money management is more commonly used than risk management. However, risk management in forex trading is a rather broad concept. It not only addresses capital issues but also other issues that traders face other risks such as computer systems used for transactions, internet transmission … All elements constitutes the risk that each trader need to face.

First see the table below to know the importance of capital management.

Forex Money Management

The table above means that once the trading account has been reduced, it is much more difficult to recover the losses. If you have lost 50% of your initial capital, trader needs to earn a profit of up to 100% for the remaining capital to return to breakeven. In particular, if trader has lost up to 90% of the initial capital, they need to earn a profit of 900% for the remaining capital, the new account will be as before. This ability is extremely unlikely.

Through the above example, we will see the importance of money management, which will help us still have capital to continue trading forex after having lost even a few consecutive orders.

Three important benefits of money management?

1. Avoiding account losses to a level that is hard to recover, strictly money management will keep trader in the safe zone of trading. 2. Avoid creating a psychological burden When Trader selects a reasonable risk tolerance (for example, if each order loses a maximum of 1% to 2% of the account), they will not suffer from psychological impact after a loss. If you choose a high risk tolerance level, after each loss, the trader will be easily afraid to enter the order, or the psychology of “revenge” will lead to a big order, the lack of discipline and post indeed, it may be worse. 3. Maintain a passion for trading Large losses and quick losses also lead to another psychological consequence, which is to reduce trader’s passion for doing trading transactions (besides reducing money). This is the most important factor that makes trader leave the market soon.

6 factors to increase the effectiveness of money management

In addition to the number of risk percentages for each transaction as described above, trader should identify some other factors for his own money management plan such as:

1. Total losses in the trading day: The maximum percentage of money allowed to lose in a trading day. If traders lose this level, trader will stop trading on that day. 2. The number of consecutive loss orders must be temporarily suspended trading: If you are a day trader, then after about 3 consecutive trades, it should take a break time about 10–30 minutes. The first reason is to avoid psychology of revenge the market, resulting in disruption of trading plans. The second is the market may be in a chaotic period or not in line with your familiar trading style. So, stopping for a while helps us to pass that stage. Relaxing your mind some minutes will also help to improve the efficiency of trading later. 3. The percentage of losses must end on the trading day: Define a certain loss point that the trader will terminate that trading day. The ratio may be 5–10% depending on the trader. For example, in the trading day, trader lost 10% from the highest account mark of the day (foe example, the capital is $1000, trader earns 50u profit to $1050, but if the loss is 10% then it will be $945), the trading day ends. 4. Number of loss days ending the trading week: If there is a loss for 2–3 consecutive days (for day trader), stop trading at the end of the week. The purpose is to stabilize psychology and avoid unpredictable market periods. 5. The total loss on the account to temporarily terminate the real transaction: The maximum percentage of capital that trader losses on the whole account (e.g. 30% — 50% of the account). If this happens, trader stops trading and switches to reevaluate his trading system or switch to demo account to rehearse. 6. Profit / loss level to increase / decrease trading volume: Trader should set a certain profit growth level (for example, 30% of accounts) to allow himself to increase the trading volume (e.g. adding 0.2 lots), or a certain loss to force yourself to reduce the trading volume.

In conclusion, when investing in or trading in the forex market, the leading factor that trader needs to remember is to ensure safety for the capital. Once an effective money management solution is available, trader can survive and seek sustainable profits. To read more about the process of money management in forex trading, click here.