Forex Money Management

[marc walton]

In general my forex money management rules are Never risk more than 5% (maximum) on any trade.
When I started with a smaller account of $2000 I risked 5% and then reduced this to 3% as my account grew to $10.000. I have since reduced this again and now 2% is my limit.
If you take two $ trades or correlated* trades at the same time then 5% is the maximum exposure you should have for both trades.

Only risk 2.5% maximum if its a counter trend trade.

ALWAYS plan and place a stop loss.

Always plan your exits BEFORE you enter the trade. If 2 trade strategy, plan 1st target & move stop to entry on 2nd – then depends on your philosophy as to whether you set a secondary target or just let it run

Do not take trades with a less than 1: 2 risk reward ratio ie If your stop is 30 pips,make sure that the trade has a good chance of making 60 pips. Therefore you need to make sure that no major emas are in the way. A double top or bottom.

If you lose 2 trades in a row, reduce your risk to 2.5%

If you lose 3 in a row STOP for the day & analyse where you went wrong. Start again at 1.5% or go to a demo, BUT trading by the rules.

After 3 wins in a row go back to 2.5%.

Once you get back to a 60%+ win ratio, go back to 5% maximum

Demo Accounts

There are two schools of thought re using a demo account. I think that you should always start with a demo. It helps you to learn how the platform works and make trades without losing real money. The flip side of this is that a lot of people trade demo accounts very badly.

They start to trade with none of the discipline & trade management that they should use on a real money account. They enter trades and dont place stop losses or targets. They may have placed a stop and then moved it another 100 pips because they are convinced its going to go back down.

The bottom line is that from day one on a demo account you need to use your money management rules. If not there is no point. You will have loads of bad habits that when transferred to a “live account” will wipe you out very quickly.

Making trades on a demo account is NOTHING like the adrenalin rush you get when you have real money on the table. If you find that you constantly break these rules on a demo account, consider opening a micro account with a few $100’s where you get bet cents per pip. Its a compromise measure. Only do this if you can afford to lose the money in the account.

Followers Question re opening a “Live” account.

So how do we approach this in the real world? 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, how do you approach it?

Moving to a “Live Account.”

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) 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.

A vitally important thing to note here is that if your 1st trade wins or loses then you have to increase or reduce your account balance calculation accordingly. For example: Your account balance is $2000 and you risked 5%/$100 and lost $100. Your next trade will be 5% of $1900, which is $95.

There is a tendency when things go wrong to keep staking the $100 as psychologically you still think of your account as a $2000. This can lead to ruin very quickly.
Remember fear and greed rule the forex market.

b) As I have explained many times before, 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 you must learn to avoid).

Now you have lost the lot. Most new forex traders quit. They just KNOW that there is money to be made here but they just can’t make a success of forex. 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 trading forex without rules & discipline is far nearer to gambling than investing). Anyone who suggests you “invest” your life savings in forex is seriously not to be trusted).

To be continued Part 2

[marc walton]

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 two lots. With the first lot I look for a profit of at least 20 pips. Bank it and then move the stop on the second lot to entry (this way I bank some pips and have the chance of catching a big move with the second).

A variation on this is sometimes, if I feel particularly confident of a bigger move, I will move the stop on the second positon to entry + 20 pips. This second part is then a risk free trade, but I have given the trade a little more room to breathe, should there be a pull-back.
If Eric decides to trade this way, he needs to split his 5% risk over 2 trades. That is 2.5% per micro lot.

How to calculate micro lot stakes

The following is an explanation that Alpari Uk gave re a client with a $2200 account:

Please do be aware that with Forex trading your profit / loss is determined by the second currency in a currency pair. So on the GBP/USD market the USD would determine this. If you have £2200 on your account and only wish to risk 5% of our deposit per trade this equals £110 per trade. With this you would be able to trade a lot size of 0.15 with a stop loss of 100 pips on the GBP/USD market.

The calculation for this is as follows:

Amount prepared to risk / stop loss distance = amount prepared to lose per pip in GBP 110 / 100 = £1.10
You then need to convert this in to the second currency in the currency pair you are trading at the spot rate on our platform. So, 1.1 * 1.38 = $1.52
A $1.52 profit / loss per pip comes from trading a lot size of 0.15 on the GBP/USD market.

If you wish to set up 3 separate orders of 0.10 lots on the same market and at the same price you would need to place 3 separate pending orders with the entry level and stop at your required levels. If you wish to place an instant execution order you would again need to place 3 separate orders.

When I was trading smaller time frames and needed to make quick decisions what I did was this; at the start of the week I did a chart with each pair I traded & what micro lot size I needed for 25, 50 , 75, 100, 125 & 150 pip stop loss. Its not perfect but it got me in the habit of knowing roughly what stake size I needed t o place.

I have just found this tool on another site, this does it all for you & automatically keeps up with current price. Brilliant. http://currensys.com/FreeForex.php

Summary
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 was discipline. I have rules, but because there was no one looking over my shoulder, I was prone to breaking those rules.

I have always worked for myself, so I am not used to doing what I am told Do not fall in to the same trap. It will either lead to ruin or extend your learning curve and draw downs.

*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 $/Chf. In November 2009 when the Chf was going up, the Euro/$ was going down 99% of the time* Over the last 12 months the average is 86%.

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. The spread is also smaller and therefore its slightly cheaper, but this is a lesser consideration. However, I do 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 November 2009 the Euro/$ and Gbp/$ went in the same direction 66% of the time. Again you have to take this into consideration and establish a rule before you start to trade.