Money management plays an extremely important role in Forex trading. Without proper risk and money management techniques, trading would not differ too much from gambling in a casino. Even the most profitable trading strategy won’t produce positive trading results if the trader doesn’t respect at least the most crucial concepts in money management. To help you out in your trading journey and to show how important Forex capital management in trading can be, we compiled a list of the top 10 Forex money management tips that every trader should know.
What is money management in Forex?
Money management refers to a set of techniques that are used to minimize your losses, maximize your profits, and grow your trading account. The top 10 Forex money management techniques described below will help you achieve exactly that – protect and grow your bottom line.
Many beginners to the market tend to neglect the importance of money management in Forex trading, which leads to a total wipeout of their trading account sooner or later. Make sure to fully understand the money management rules explained in our Forex trading presentation before placing your next trade on the market, and you’ll soon notice the difference in your trading performance. Let’s take a look at the top Forex money management strategies in the following lines.
#1 Decide how much you want to risk per trade
One of the most important money management techniques in Forex trading is the so-called risk-per-trade technique. Risk-per-trade determines how much of your trading account you’re risking on any single trade. As a rule of thumb, don’t risk more than 2-3% of your account on a trade, so you’ll have enough funds to withstand the negative impact of a series of losing days. It’s always better to risk small and grow your account steadily than to risk too much and blow your trading funds.
#2 Don’t overtrade the market
You don’t have to make a trade every single hour, or even every single day. Wait for the trade setup to form and don’t chase the market for trading opportunities. The market doesn’t owe you anything, and patience and discipline is the Holy Grail of profitable traders. Even the best Forex money management system won’t help you much if you make multiple trades without any market analysis.
#3 Cut your losses short and let your profits run
If you’ve followed international Forex tips on trading, you might have heard about the saying “Cut your losses short and let your profits run.” Professional Forex traders do just that – they’re very impatient about their losses and close a losing position early, but let their winning positions run. Beginners to the market do it the opposite way – they let their losses run, hoping they will revert, and cut their profits short on fears they'll miss out on them.
#4 Always use Stop Loss orders
Stop Loss orders are a major building block of risk and money management, and should be an integral part of any Forex money management plan. A Stop Loss order automatically closes your position when the price reaches a pre-specified level, preventing larger losses. All Forex trading money management strategies should incorporate Stop Loss orders.
#5 Chase trades with a reward-to-risk ratio of at least 1
Research by a large Forex broker has shown that traders who make trades with a reward-to-risk ratio of 1 or higher are significantly more profitable than traders who trade with a R/R ratio of below 1. The reward-to-risk ratio, or R/R, refers to the ratio between the potential profits and the potential losses of a trade. For example, if you buy GBP/USD with a Take Profit of 100 pips and a Stop Loss of 50 pips, the R/R ratio of that trade would be 2. If you only take trades with R/R ratios higher than 1, you’ll need a relatively smaller amount of winning trades to break even.
#6 Calculate your position size correctly
Many traders don’t know how to correctly calculate their position size to maintain their defined risk-per-trade. Position sizes are crucial in Forex money management, as they define a trade's potential profit.
To calculate your position size correctly, take the Stop Loss size of a trade setup and divide your risk-per-trade with that Stop Loss size in pips. The result will equal the maximum pip value you’re able to take to maintain your defined risk-per-trade. For example, if your risk-per-trade is $100 and your Stop Loss is 10 pips, your position value should equal a pip value of $10/pip.
#7 Be cautious when trading on leverage
Trading on leverage is one of the main reasons why so many new traders are attracted to the Forex market in the first place, but you need to be aware that leverage is a double-edged sword. Leverage can magnify both your profits and losses.
#8 Don’t be greedy
Greed and fear are among the most devastating emotions in trading. With experience, you’ll learn how to handle your emotions so that they don’t interfere with your trading decisions. Greed is especially devastating – you need to be realistic about what you can squeeze out of the market. Don’t overtrade the market and don’t set unrealistic profit targets that are impossible to achieve. A trade with a 10-pip Stop Loss and 1,000-pip profit target will likely result in a loss.
#9 Use trailing stops to lock your profits
A well-thought-out Forex trading money management system should include various types of Stop Loss orders for different types of market conditions. If a market is in a strong trend, it might be wise to use a trailing stop set at the average height of the correction wave. This way, you’ll constantly lock in profits while the trend is performing, as the trailing stop will automatically move your Stop Loss.
#10 Understand currency correlations
Last but not least, understanding and taking advantage of currency correlations should be a part of all Forex investment plans and Forex money management strategies. Currency correlations reflect the degree to which a currency pair will move in tandem with another pair. The correlation coefficient, which can take a value of between -1 and 1, should be used to create a Forex portfolio of trades which diversifies the total trading risk.