Money Management is often a complicated discipline but able to give thickness and security guarantees to its trading activity. Here are some useful tips.
The Forex Trading is a potentially profitable business but also very full of dangers. One of the resources to reduce risks is to practice good Money Management. This term indicates the discipline that consists in planning not only the possible economic income but also the possible losses, in order to have at any moment a plastic vision of the money that is being risked.
Money Management is a practice that the trader cannot give up. Also because the economic catastrophe is always around the corner. Just think about the more (sadly) famous statistics of Forex Trading: about 90% of traders close the year at a loss!
Unfortunately, Money Management is also a difficult discipline. It requires commitment and time to be carried out to the best, as well as a considerable technical baggage. In this article we will try to facilitate its development by offering some useful tips.
10 Advice for a Money Management up to this name
The 2% rule
Let it be clear, it is a fairly arbitrary indication, the result of a convention rather than a mathematical calculation. However, it is a common sense rule, which is based on the principle of prudence. It states that it is always good to invest, for a single trade, no more than 2% of the entire capital. In this way, even in the worst case scenario, dozens and dozens of trades would be needed before losing (almost) all the available capital. It is a widely used and therefore reliable rule.
The question of capitalization
Forex Trading has achieved some success among ordinary people due to entry barriers, which are lower than other speculative investment activities. This is especially thanks to brokers that allow you to open accounts with small amounts, often a few hundred euros. However, it is not recommended to operate if you have “a few pennies” available. This is for two reasons: first, earnings are derisory; second, we are encouraged to use risky techniques to grind profits, for example.
Some brokers advertise themselves as the main attraction for the offer of “strong” financial levers, even if the authorities are trying to limit marginal operations as much as possible. This is an attitude that, however legitimate, can mislead the less experienced trader, who can move leverage as an ordinary tool. Well, it is a real double-edged blade, also because the risk is not only to increase profits but also to increase losses exponentially! Therefore, the advice is to use levers that do not exceed 1:50.
The right risk-return ratio
Here we enter the technician. The risk-return ratio is the ratio between the maximum possible loss and the maximum possible gain. The first term is determined by the stop loss, the second term is determined by the take profit (even if some use the more complex trailing stops). However, by convention, it is good to program your trade, then exit points, so that the maximum gain possible exceeds at least twice the maximum possible loss. The more cautious, then, refer to a ratio of 1:3.
The overall look
It often happens that the trader receives, or revenues, strong signs of entry and, nevertheless, the subsequent trade proves bankruptcy. This can happen for a variety of reasons, but the most frequent one has to do with volatility. If the market is volatile, and signals are produced with an analysis that is too limited in time, it is likely that the signal is false or misleading. So, before opening a position, take a general look and check that the market does not fall into a volatile situation.
Reinvest the profits
A very conservative approach to Money Management is based on a simple rule: reinvesting profits. That is, given a precise period of time, always commit only the gains and not the initial capital, regardless of the 2% rule. This is a way to reduce the pressure, since you have the feeling of not risking anything, but also to preserve the money. Of course, the risk is to produce returns that are too low.
Notice to the frenzy
The scalping is the preserve of the experts. It’s true, the scalping is tempting to many. First, because it promises huge profits, secondly because it is adrenaline. However, it is also very difficult to practice. The risk of not holding up the pressure and not being able to make decisions (and interpreting the market) quickly is really high. So, before opening and closing positions at a frantic pace, think twice.
Call for martingale
The martingale is a very famous method of investment, more outside the trading than in trading to tell the truth. It consists in investing, after a loss, exactly twice what has been invested in the previous trade. In this way, just for a mathematical question, even if you continue to lose large sums, once the victory has come, this would reward the interests of all the previous defeats. Well, the martingale goes against all the principles of Money Management and even against the principles of prudence. He is really capable of burning capital in a handful of trades. So, avoid it.
Always set Stop Loss and Take Profit
Some hasty traders do not set either Stop Loss or Take Profit, but they go on the arm, perhaps with a very thorough market analysis. Well, it is always necessary to set these levels to limit the damage in case of losing trade, to preserve the gains in case of winning trade. It is not even too difficult, if one uses the most basic approach, that is, the one that refers to supports and resistances (often corresponding to periodic minimum and maximums).