Money Management: What, Why & How?

As with most things in life, like working out and dieting, money management is something that most traders preach but few, in fact, actively practise in real life. Why? Just like watching what you eat and hauling yourself from the sofa to the gym, regularly managing your money in forex can seem like a burden and is often thought of as a tiresome activity.

So, to help you identify how you could benefit from money management and potentially avoid losing money in forex trading, in today’s blog post, we’re discussing the importance of integrating money management into your forex trading strategy and detailing exactly how crucial this is for building long-term trading success.

What?

‘Is forex trading profitable?’ those new to the forex market ask. Potentially, yes, so long as certain factors are considered and money is correctly managed to best aid success. Money management in forex refers to a particular set of rules that help you to maximise your profits, minimise potential losses and expand your trading profile. More often that not, it’s those new to forex trading who tend to neglect basic money management rules and end up blowing their accounts as a result.

So, even if you’re confident that you have the best trading strategy out there, this won’t be able to help you unless you have a sound understanding of risk per trade and reward-to-risk ratios, or if you trade too aggressively or don’t use stop-loss orders effectively.

Why?

Due to its volatility, the forex market is intrinsically risky. To safeguard your finances, money management should be considered a non-negotiable success strategy for both novice traders and forex veterans alike – after all, without proper money management, you simply can’t become a profitable trader.

For example, let’s consider the following scenario…

One trader has a brilliant forex trading strategy and is profitable 95% of the time, but they don’t manage their risk at all. Conversely, another trader has a trading strategy with an average 60% winning rate, yet they utilise and follow the best money management rules. Who do you think will finish the month with the most profits? The answer is our second trader, as the first is far more likely to lose their entire profits on a single losing trade.

Where many traders go wrong is in failing to realise that you shouldn’t only plan on gaining profit from a single trade, but, in fact, also base your strategy on achieving gains over a long period of time. This is where the ability to manage your finances and trade capital becomes vital.

How?

  • Avoid trading aggressively – This is the downfall of many novice traders – so we suggest considering whether or not a small sequence of losses would be enough to eradicate most of your risk capital. If so, this suggests that each trade has too much risk attached to it. Having a strict, documented trading plan that contains aspects of money management will help you to manage risk, helping you avoid aggressive, emotional trading
  • Use stop-losses – A stop-loss order will guarantee that you won’t lose a substantial amount of money on a single trade, and will shield your investment from unexpected shifts in the market. Since the possibility of a loss always exists, set your stop-loss order so that it exceeds no more than 2% of your trading balance for any given trade
  • Understand leverage – Although leverage offers the opportunity to magnify profits made from your available risk capital, traders need to understand that a higher leverage also increases the potential loss per trade. As a result, we suggest only using leverage when you have a clear understanding of the potential losses
  • Think long-term – Naturally, a success or failure of a trade will be determined by how it performs in the long term – so ensure you remain wary of risking your future success by placing too much importance on the success or failure of a current trade. In addition to this, ensure you refer to a forex economic calendar, keeping up-to-date with current affairs and other developments in the news to inform your strategy and money management for future trades

As we hope you can now see, money management in forex is as varied, flexible and full of potential as the market itself. The golden rule to follow is that all traders in this market must practise some form of it in order to see potential profit and to be deemed successful. For more useful tips and professional advice on how to best prepare yourself for your trading journey, sign up to one of our free seminars, where you can learn forex strategies that are sure to put you in good stead for your forex career.