Money management is the most important aspect to success in forex trading. It also happens to be the most over-looked and least practiced part of forex trading.
Money management and psychology go hand in hand in the markets; you won’t have the proper psychological mindset to consistently profit if you do not have a sound money management plan to go with your overall trading plan. Here are some money management truths that will give you a better idea of what you should or should not be doing with your money in the forex market.
Do demo trade for at least 1-3 months before trading your real hard earned money. Ideally you should be demo trading until you are seeing consist profits and have a well thought out trading plan.
Do start out trading with the same amount of money in your demo account that you plan on starting with when you go live. In order for demo trading to have any real benefit on your actual long-term trading success you need to take it as seriously as possible. Many people start demo trading with 100k in their account and then go live with a 5 or 10k and expect to make the same returns, a sure fire way to lose all your money in the blink of an eye.
Do make sure you are setting your profit target to be at least as big as the amount you are risking. Ideally you should shoot for a risk/reward of 1:2 or better. This means if you are risking 100$ on a trade your reward should be 200$ or greater. This way, even if you lose 50% of your trades you will still make money. If your risk/reward is 1:3 than you can lose 66% of your trades and still make money over the long run. This would mean if risk 100$ per trade, and you lose two trades out of three you would still profit 100$. Behold the power of the risk/reward ratio.
Do have a method for reducing your risk when you are experiencing a losing streak. It is easy to get caught up in the moment after a few losing trades and jump back in the market and try to make your money back. However, this is the last thing you should be doing; you should be reducing your risk after every loss and remaining patient for the next setup that fits your pre-defined rules. A good way to implement this is to have a set percentage that you risk on each trade. So if you risk say 2% of your account on any one trade than as your account takes hits your overall dollar amount per trade will be less than the last one trade, still just 2% of your total account value. Conversely, when you are in the midst of a winning streak all you have to do is continue to hold your risk at 2% and you will be risking a larger dollar amount per trade than on the previous trade, this is what you want.
Don’t increase your risk to try and make back money that you just lost. This is probably the cardinal sin of trading. It is really hard to not do this as the feeling of wanting to do this can be overwhelming at times after losing a trade. This is why you need a pre-defined money management plan
Don’t trade with money you can’t afford to lose. If you are using money you could be using for other life necessities than you should not be trading in the first place. Forex trading is very risky and can only be mastered with strict discipline and sound money management.
