Money management and the rules of risk trading – ForexLive

The importance of money management

RBFX
On the market, the trader is always risking. As a
rule, a beginner thinks little about it and my afford to risk without
further thought, suffering critical losses. With time, when the trader gains
experience, they begin to realize that there is something wrong to it. In
trades, the trader loses more than earns, thought there might be more
profitable trades than losing ones. Analyzing the history of their trades, they
see that they make an insignificant profit, while the losses are substantial.
Now let us figure out how we can reverse the trend and carry out large
profitable trades, limiting losing ones. This is what money management is meant
for.

The main goal of money management is to save money and
minimize losses. It is no secret that the risk to profit ratio must be in favor
of the profit. It sounds logical, but what with the numbers? There are many
opinions on this, but the optimal strategy is never to lose more than you can
afford. If you cannot minimize losing positions, you need to minimize losses on
them.

The most widespread profit to risk ratio is 3:1. This
means that of three earned points the trader may lose just one.

👉 To find
more information about money
management
, please see this article.

Example

The trader opens a position on which they plan to make
a profit of 120 points; in this case, their maximal loss cannot be over 40
points. The numbers may alter in accordance with the situation, but anyway the
potential profit should be in proportion with the possible loss.

Apart from the profit to loss ratio, there are many
other rules
of money management
, such as risk on deposit. Ideally, the overall sum
that the trader may risk at one trade may be 1%, 2%, or more. However, looking
more critically, a risk of 2% per open position provides optimal trading. At
the first sight, this ratio seems quite hard to keep to, but try using a
calculator and seeing the real numbers.

Example

Imagine the trader has a deposit of 10,000 USD. The
trader decides to open a trade sized 1 lot for EUR/USD (for
easier calculation, let us consider 1 point of price movements equal 10 USD,
this sum will differ depending on the currency pair and currency rates). Now,
we have a deposit of 10,000 USD and a 2% risk on trade, which means the trader
may afford to lose 200 USD or 20 points. If this risk is not in compliance with
the trading
strategy,
the position being opened must be reduced in size. If
the trade is opened or 0.5 lot, we increase the amount of points risked while
the sum of 200 USD remains unchanged.

Let us go on with calculations. If the trader makes a
profit, they remain satisfied and things go on. However, we are calculating
possible losses. If 200 USD is lost, only 9,800 USD remains on the account. In
the next trade, the trader may also incorporate a risk of 2%. With the current
balance, it makes 196 USD; if the risk is more, the rule of 2% will be broken.
And then we go on counting this way, incorporating a risk of 2% from the
balance in each trade.

Another important criterion for beginner and
inexperienced traders is the number of positions opened simultaneously. One or
two positions opened at once will be the best decision. More open position will
make risks much harder to control.

Apart from what we have mentioned, there are many
other options of minimizing losses and trading without excessive risks. For
example, even before they start
trading
, the trader can define the conditions that will make
them close all operations for today.

Such
criteria may be:

  • Time
    for trading – 3 hours
  • Sum
    earned – 600 USD
  • Overall
    losses during a trading session – 200 USD (based on the ratio 3:1)
  • More
    criteria may be added, such as the number of opened orders or something else.
    If any of the conditions is fulfilled, it is recommended to stop trading for
    today.

👉 More
profound information about models
of money management
you can find here.

Bottom line

Regardless of the sum that the trader has on the
deposit, money management will help if not fully eliminate losses then minimize
them and remain with a profit. Analyzing the statistics of successful traders,
we can see that even they cannot avoid losing trades, so you should keep calm
and control your emotions.

This article was
submitted by Dmitriy Gurkovskiy, Financial Expert and Author at RoboForex
Blog

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