Forex trading isn’t all about getting the right analytics and strategies. In fact, a great deal of trading in this financial market is actually about solid forex money management.
Managing your funds correctly is what will ensure that you keep your account going — and there are many things that can potentially threaten your forex money management if you aren’t paying attention. Here are a few of the leading threats to money management and how to manage your risks to ensure success…
The Dangers of Poor Money Management
The forex market doesn’t just move incredibly quickly — it also involves large amounts of leverage.
When your account is leveraged 200:1, a single large trade could wipe your account out. This is exactly the situation that you want to avoid. The first thing you need to understand about forex trading and the market is that it doesn’t operate like other markets do; every risk and every reward is amplified. So while you’ll make impressive amounts of money right out the gate, there will also be the potential to lose that money.
The second thing you need to know about the forex trading market is that the amount of money you can make is related to the amount of cash that you have in your account, even with leverage in place. That means that every loss damages all of your future earnings when you are trading a large amount of your account; if you need to rebuild your account from a significant loss, you’re going to find yourself doing it at a turtle’s pace compared to the leaps forward that you were making previously.
Poor money management can quickly turn a winning account into a losing one — and it can happen in 24 hours or less.
There are issues that can occur that will exacerbate the problem, but in reality, simply losing track of your trades for a few hours is more than enough to create a money management issue. Even if each subsequent individual trade is a successful one, poor money management will let a very bad trade become a terrible one. And poor money management can happen for a variety of reasons: a simple lack of attention at a critical moment, emotional investing, or even a global event.
Improving Your Forex Money Management
So here are a few of the most effective management techniques to use to safeguard your trades.
- Always use stop losses and take profits. Stop losses in particular will help with your money management by making sure that your trades never go negative beyond what you can accept as a loss. The problem with the forex market (and what makes it so great) is that the forex market moves incredibly fast. If you’re relying purely on your ability to close a trade quickly, you may find yourself in for a bad surprise. Stop losses will make it easier for you to ensure that you don’t accidentally let a trade run too far.
- Only initiate a few trades at a time. And these trades should only be a small portion of your account at any given time. You need to make sure that even with leverage your account is not going to potentially experience a margin call. The easiest way to ensure this is to simply not risk a large portion of your account. But moreover, initiating a few trades at a time is what forex trading is all about. You aren’t dealing with thousands of stocks, you’re dealing with a dozen base currency pairs. This means that you need to concentrate on your currency pairs and each trade — the more trades you have open, the more likely it is for you to lose track of them.
- Don’t leave your trades open. Your trading strategy should include how long you leave your trading open for; if your trading strategy is a daily one, close out your trades at the end of the day. If your trading strategy is a weekly one, you need to make sure those trades are closed at the end of the week. Otherwise you will find that you let your trades run for longer than is reasonable. The forex market is a very fast one. The analytics that you use to go into a trade are not likely to persist beyond the timeline of your strategy. And the longer you leave those trades open, the more likely it is that you’re going to lose track of the trades, and find yourself with an account that has been margin called or has lost more than it should. Further, if your trade is persisting outside of your trading strategy, it’s likely that the initial trading analytics were simply incorrect — it happens, and it’s time to move on. You don’t want to leave your account tied up in a trade that isn’t going anywhere!
- Don’t become an emotional trader. Money management is about managing risk, and the enemy of risk tends to be your own personal emotions. You need to make sure that you’re thinking each trade through and you aren’t letting trades ride just because you’re “certain” or have a “gut instinct” that it will turn around. Remember: time spent on a losing trade is time that is not winning. If there is a trade that hasn’t been unsuccessful, it’s often better to cut your losses and run rather than try to recapture profit. You could instead be capturing profit through successful trades all the time. Failed trades happen even to the very best of investors, and it isn’t something that you need to feel poorly about.
- Avoid trading the same currency in the same direction. If you have a EUR/USD trade open, you don’t want to open a USD/JPY trade in the other direction. This is where many people who are following their analytics but not thinking about their money management will falter. It’s easy to just look at the raw data and think to yourself “that’s a good trade,” but the truth is that the EUR/USD and USD/JPY trades will be performing inversely often because of either the strength or weakness of the dollar. When the dollar then dramatically shifts — either up or down — both trades will move. That might seem like a good idea, but it’s really a loss of control, because you now have too much money tied up in a single trade. Note that this doesn’t count if you intentionally trade only half your tradable funds in each; this could be seen as a form of hedging.
- Don’t trade too much of your account at once. Regardless of how solid the trades are or how diverse they are, you should never be trading in a volume that would threaten your account margin. Some individuals trade 10% of their cash, other 20%, and some brave souls could trade up to 25%. Set your amount early and do not deviate. Remember: trading, especially high stakes trading, is all about consistency.
Forex money management is what will separate successes from failures.
Everyone can create, stumble upon, or just follow a successful trading strategy, but few traders have the discipline and the knowledge to ensure that their money management techniques are consistent. With appropriate money management, you’ll be able to build your account, generate revenue, and avoid any potential shortfalls that could end your trading career.