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One of the major differences between a successful trader and an unsuccessful one is the way they do Forex money management. Sometimes traders ignore this part out of lack of knowledge on the matter. So here, we tackle this lesser-known part of Forex trading. What is Forex money management? Why is it important? And how can you excel at practicing it? Read on to find out.
Forex Money Management: What is it?
Traders who implement money management effectively have one thing in common: discipline. As most rules are self-imposed, self-restraint and wisdom are key. Managing money means minimizing losses, maximizing profits, and growing your trading account. That is why it is sometimes confused with risk management. However, risk management focuses on identifying and analyzing the risks associated with trading. And by doing so, lower your exposure to said risks of loss. Whereas money management is the practice of actively protecting your money to become a successful Forex trader.
Five OspreyFX Tips
There is a lot to take in when you are starting your Forex journey. So to make things easier, here’s a list of five recommended tips for an efficient Forex money management system.
Trade What you can Afford to Lose
The wisest advice you can get about money management is to only trade what you can afford to lose. As a beginner, it is good practice to deposit the exact amount you are willing to invest in trading. Not more. One way to avoid overspending is to set yourself a maximum amount of acceptable loss per month. If you hit that loss, just stop trading. The concept behind this approach is to keep your trades within a certain financial comfort zone. This way, losing any capital will not affect your life. It is not a good idea to over-invest and use up the money needed for essentials – such as rent, food, etc. Thus, categorize your income accordingly, and use the extra amount for trading.
Identify the Risk Percentage per Trade
After deciding on your monthly budget cap for trading, it is time to establish an acceptable risk per trade. By doing so, you can place an effective stop loss for each trade. It is common to risk a fixed percentage of your balance. Once you know how much you intend to risk, you can think about your profit goal. And set up your take profit accordingly.
Your strategy and budget will determine the percentage of risk to set. For example, a risk to reward ratio of 1:1 means that your acceptable loss is the same amount as your profit target. A ratio of 1:3 however would give a target profit 3 times higher than the loss. Generally, the risk to reward ratio is higher than 1:1.
Leverage: A Double-Edged Sword
Leverage allows Forex traders to have larger positions than their budget permits. The trader borrows money from their broker to open a leveraged position. If applied properly, it can be a helpful tactic to increase profits. While this may seem like a fantastic deal for the trader, it is a double-edged sword. Amplified revenue on winning trades, may also turn into amplified losses on losing trades. Therefore, use leverage only with a lot of awareness and wisdom.
Withdraw – Cut loss and take profit
Many Forex traders get too involved in their trades and often ignore the basic principle of withdrawing their profits. It is often a rule in life as well. So, if you start to generate a good stream of income from your trading, take it out. It is the purpose of Forex money management to allow you to benefit from your profits, by avoiding losses and errors. The longer you have capital in your account, the more likely you are to trade it rashly and lose it.
Use Stop-Losses Orders
Using stop-loss orders is key in implementing an efficient Forex money management strategy. These help you maintain control over your trades. Here are the different types of stop-loss orders:
- Chart Stops – Use this to include price-chart technical parameters in determining your stop-loss.
- Volatility Stops – Use this to close a trade once the instrument reaches a certain volatility level.
- Equity Stops – Use this to set a percentage of your trading account as a stop-loss marker.
- Time Stops – Use this to close your trades by the end of a trading session, trading day, or trading week.
In Forex, even for a seasoned trader, there is always knowledge to be learned, tips to be explored, and strategies to be discovered. Our advice for money management is to stick to your self-imposed rules and goals. It is a good idea to write down your risk percentage, the risk to reward ratio, and accepted losses in your trading diary. And the best way forward is to practice. The old adage is true: practice makes perfect. You may even start your journey with a demo account. Happy trading!
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