Without proper risk management, your trading career will be short-lived
Money management is one of the most critical factors in your success as a forex trader. You will often hear people telling you different reasons for their failure as a trader. If you study their journey closely, you will find that a lack of money management is the foremost reason. If you fail to manage, you manage to fail. You will also hear people making thousands of dollars a month. It is not difficult to earn such sum of money. But it can be done only after years of study and practice. Those newbie who have earned thousands of dollars from small account during their initial stages of trading are either being lucky or risking too much. In either case they will lose most of it sooner or later. If you give all of world’s money to such traders, a financial crisis will be around the corner. You don’t want end up like that. So keep in mind that you are not going to earn thousands during the first year of your trading.
Risk Management
Money management is nothing but a proper risk management. The basic principle of money management is not to risk money more than you can afford. No one likes to lose money. But accept the fact that you will lose some trades. Even the best traders have losing trades. In fact many times accepting the loss quickly will benefit you more than staying with the losing trade hoping to turn around.
Risk only 2% of Your Account
Practical way of better risk management is to risk not more than 2% of your account on any trade. The logic behind this figure is that you will stay in the game longer. If you have a streak of 5 losing trades, you will be down 10%. If you risk more than that which most novice traders do, you will drawdown your account significantly. If you have been in such situation previously, you will realize how difficult just to come at the breakeven. The purpose of 2% is not only to save your account but also to save emotional errors in your future judgments. If you lose a large portion of your account by risking way beyond your limits, you will want to earn back all those money by overtrading. This is where most traders fail. 95% of the people who start trading lose at this game. This is one of the major reasons for their failure. You don’t want to do the same mistake. So make it your second nature to risk only 2% of your account on any trade.
Position Sizing
When you risk 2% of your account on a particular trade, you put a stop loss at certain price which if hit will result in a loss of 2%. Some trading strategies like price action require setting wider stops. Wider stop doesn’t mean more risk. You should adjust your deal size in a way that you will risk only 2%. Say you generally take a trade of size $ 10,000 on an account of $ 10,000. At 2%, you can afford to risk $ 200 on a single trade. Now your stop of 200 pips results in $ 400 loss, you reduce the trade size to $ 5,000. Similarly, with 100 pips stop, you can double the size to $ 20,000. So instead of adjusting the risk you adjust the trade size. This is called position sizing. It is one of the better risk management tools which are simple yet effective for better trading results.
You can learn from the mistakes of other traders. Life, especially trading life is too short to experience the every mistake and learn from them. So learn these basic money management tools and practice with the demo account. Remember it is not how much you win but how much you lose that will differentiate the successful traders from others.
