Understanding Forex - #4 - Money Management
This is a series of articles on the foreign exchange market. You will learn here what Forex is, how it works and how profitable it can be. The entire series contains the following articles. . .
- What is Forex?
- Technical analysis
- Fundamental analysis
- Money management
- Compound interest
Money management.
This is one of the most important aspects of a good trading system. Even if your market forecasts are accurate, you may still not be profitable in the long run unless you implement proper money management techniques.
Money management refers to how you manage your trading capital. It has to do with how much money you invest in each trade. Also, how much do you expect to earn on each trade compared to how much you are risking. Furthermore, you can also use different types of orders that allow you to automatically manage your trades such as stop loss, limit order and trailing stop.
In my opinion, the two most important aspects of money management are position sizing and expectation. Position size refers to the size of your positions. You shouldn't risk more than 1% - 2% per trade.
Expectation refers to how much you expect to earn versus how much you are willing to lose. The expectation should always be positive. For example, if you enter a position and expect to make a profit of 50 pips while you are only willing to lose 15 pips, this is a positive expectation.
The example above means you can get it wrong three times in a row and still be profitable the fourth time. One way to implement a positive expectation on your trading strategies is to use trailing stops. I will now explain this and the other orders I mentioned above.
Let's start with a stop loss order. This helps you to automatically close a losing position and prevent your total trading capital from decreasing. Why do you need stop orders? Many things could go against you and waste a lot of time.
The platform you are walking on may freeze. The place / computer you are trading from may shut down. Market news could quickly drive the price of currencies crazy. Do you get the point? Many people use stop loss orders only as & # 8220; insurance & # 8221; against these ongoing events.
Another thing a stop loss order might be useful for is establishing an automated trading system. Some trading systems don't require you to be in front of your computer all day. You can set them on autopilot and let the market / platform do its thing. If the market moves against you, the stop loss will be triggered and your losing position will be canceled automatically.
The second order above is the limit order. This is useful for automatically making a profit once the price of the currency pair has moved to the desired level. You can use a limit order for the same purpose that you use a stop loss order. It is good to automate your trading in general. Once the target price is reached, the limit order will be activated canceling the winning position and preventing it from turning into a losing position.
Now, something very important in trading & # 8220; reduce your losses, let your winners run. & # 8221; Most traders do it in reverse. That's why I forgive in the long run.
One of the simplest ways to implement this technique is to use a trailing stop. This type of orders allows you to get a positive expectation, which is one of the most important aspects of money management as mentioned above.
A trailing stop is like a limit order and a stop order at the same time. For example, let's say you enter a position and the market moves in your favor. Then notice what happens.
With a trailing stop you have a chance that you don't have with a limit order. If the market continues to move in the expected direction, the trailing stop order will move with the market. This way there is no limit to the profits you can make. If, on the other hand, after moving in your favor, the trend retraces a certain percentage, the trailing stop will be activated, canceling the position and preventing it from turning into a losing trade.
These are common techniques used in the most successful trading systems. You can learn other important aspects about Forex such as technical analysis and fundamental analysis from other articles in this series.