Forex Money Management.

Many of you are asking me to explain forex money management. Managing your money is THE most important part of forex. If you have none left you can’t be a forex trader !

Eric sent me this, so I will use his figures to show you how I would manage his account; “I will be opening a $10,000 live account and I want to make a profit of $2,000 a month ($100 a day) and risk no more than $1,000 a month. I’ve been trying a demo account with a credit of $10k and have been successful in making a $100 a day, but
since I don’t have a good money management plan, I would risk too much on trades sometimes.”

The MOST important part of forex trading is to not lose your trading bank. To do this we need to strictly control the amount of money we are willing to risk per trade. Presuming that you have traded a demo account and now feel confident enough in your methods to get in to forex for real.

This is how I would approach Erics account; 1) I would leave $8000 in the bank and only start with $2.000. Why ?
Often a new trader will blow their bank in a short period of time. A simple conclusion: It would be better to blow a $2000 bank than a $10.000. Then go back to a demo
and learn from your mistakes.

a) Making trades on a demo account is NOTHING like the adrenalin rush you get when you have real money on the table. On a $10.000 account I recommend that you risk no more than 2.5% of your account per trade.

Why ? Because if you have a losing streak you would need to lose 40 times before you wipe your bank out. On a $10.000 account that would be risking $250. But believe me that that if you go straight to risking $250 per trade and have a few losses early on you can scare yourself from pulling the trigger later on.

Remember fear and greed rule the forex market.

b) As I have explained many times before in the free lessons section:
http://forex-fxtrader.com/Free-forex-training.html 95% of new traders lose money.

Often a new trader will blow their bank in a short period of time. There is a strange psychology that comes in to play where you are say $1500 down. You now have $500 left. Mentally you seem to write it off. You now ignore all the rules and keep going for the “big one” to win it all back. The obvious outcome is that you lose the lot.

I have done this twice in my early days. You know you should stop, but the urge to “win it back” over rides your common sense, (revenge trading is a very dangerous habit to avoid).

Now you have lost the lot. Most fx traders quit. The rest dust themselves down, go back to a demo account and come back again when they have another bank not unlike a gambler in a casino. (Personally I think that forex is far nearer to gambling than investing.

Anyone who suggests you “invest” your life savings in forex is seriously not to be trusted).

Correlation

No matter which path you choose, decide on your rules and write them down. “I will risk a maximum of 5% per trade.”  Be careful here because some forex pairs are directly correlated.Correlation refers to the way pairs react in relation to each other.

Especially the euro/usd and the $/chf.
In april 2009 when the chf was going up, the euro/$ was going down 92% of the time* Over the last 12 months the average is 80%.

Therefore a buy on the chf/$ is almost identical to a sell on the euro/$. I mainly trade the euro/$ because this pair moves, on average, 30 pips more per day than the chf,** thus you have the opportunity to gain more pips. However, I closely watch the chf to assist, especially in deciding on entries and exits.

If I was to take both trades and my rules say only risk 5% of my bank per trade, I would have to risk 2.5% on the euro part and 2.5% on the chf. Also, you have to consider that a gbp/$ and euro/$ trade is very similar in that both are betting that the $ is going to go either up or down.

In April 2009 the euro/$ and gbp/$ went in the same direction 62% of the time.** Again you have to take this into consideration and establish a rule before you start to trade.

Back to Erics’ question. Lets assume he takes my advice and decides to start with a $2000 micro account. His maximum risk will be 5%/$100 per trade. My method of trading is to buy 2 lots. With the 1st lot I look for a profit of at least 20 pips. Bank it and then move the stop on the 2nd lot to entry (this way I bank some pips and have the chance of catching a big move with the second).

If Eric decides to trade this way, he needs to split his 5% risk over 2 trades. That is 2.5% per lot. I will explain in a new post how to calculate micro lot sizes.

Money management is fundamental to your success in forex. You have to make rules, but most importantly, you have to follow those rules. My biggest weakness in forex trading is discipline. I have rules, but because there is no one looking over my shoulder, I am prone to break those rules. I have always worked for myself, so I am not used to doing what I am told !

* source for correlations, fxstreet: http://www.dailyfx.com/story/charting_center/fx_correlations/FX_Correlations__May___How_Do_1241196771559.html

* source for average daily ranges
http://www.global-view.com/forex-trading-tools/chartpts.html

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