Most, if not all, of the retail forex traders today have been enticed into putting their money on the line, lured into the stormy world of forex trading by the possibility of hitting the ‘big one’ like George Soros who shorted the British pound and walked away with a cool $1-billion profit after a single day’s trade. But truth be told, the majority often end up either hitting one big loss or stringing a succession of small loses which drastically impair their invested capital and prevent them from trading any further – with very little chance to recoup their losses. They tend to focus so much on hitting that one big trade, chasing the market ceaselessly, in the process incurring losses which ultimately boot them out of the market for good.
If they only stopped for a while and do some pencil pushing to calculate the implications of their losses to their equity, they probably would have survived long enough to hit the big one. Doing some margin calculations would have made them realize that:
- Losing 25% of their capital on a single trade would require that they achieve 33% return on the next trade merely to restore their equity to the original values;
- Losing 50% would require 100% return on the next trade;
- Losing 75% would require 400% return; and
- Losing 90% would require 1,000% return.
From the above calculations, it is quite clear that recovery can become a herculean task that may even be too tough for the ordinary retail traders to handle. The sad fact is that trading losses are inevitable. Also, the possibility of stringing a succession of losses is also unavoidable. However, what we can avoid is ending up with drastically impaired capital despite stringing a series of losing trades. We can achieve this by having a prudent money management and a practical exit strategy in place.
Money management in Forex means controlling the amount of risk capital you put on the line on every single trade including having strategic trading stops in place to limit your losses. Money management strategies can be varied and flexible as the currency market itself, but here are some practical tips you can put in place:
- Never risk more than 2% of your account equity on a single trade. Use this to calculate where you should put your trading stops so that you won’t lose more than 2% on any trade.
- Put more weight on trading stops that are near or at significant support and resistance lines.
- Implement position sizing when getting into a trade.
Rule 1: Risk no more than 2% of account balance;
Rule 2: Use natural support/resistance to set the stop-loss; and
Rule 3: Use the range between current price and the proposed stop-loss to calculate lot size.
Go one step further with these related books:
- Forex For Beginners
- A Three Dimensional Approach To Forex Trading
- Understanding Price Action: practical analysis of the 5-minute time frame
- Quantitative Trading with R: Understanding Mathematical and Computational Tools from a Quant’s Perspective
- The Death of Money: The Coming Collapse of the International Monetary System
- Economics of Monetary Union