Learn Forex Trading for Beginners

Beginner
Trading101
20 Lessons
20 Hours

Basics of Money Management in Forex Trading

A trader’s journey in the Forex world is made of both losing and winning trades. No one holds a crystal ball in Forex trading. And, judging by how the market keeps changing, there won’t be a “one size fits all” trading strategy anytime soon. Therefore, the key to mastering financial markets comes from managing money.

Or, managing the risk. Money management and risk management are the same in Forex trading.

When traders set the stop loss of any given trade, they set the risk. Also, when setting the take profit of any given trade, they set the target or the reward.

There is an old saying that goes like this: “know your way out before you go in.” Money management is all about just that!

When traders set the volume of a trade, they set the risk too. One thing is to set the stop loss, but then, how much of the trading account is at risk by such a move?

The volume allows traders to use percentages on every trade. More about this a bit later.

Money Management – the Holy Grail in Forex Trading

If there’s a holy grail in trading, that’s money management. At different scales, each retail trader is a money manager.

Because traders handle the funds in their trading account, money management skills should be a priority before anything else.

Having the Right Mindset

Forex trading, like any other financial market, is a dog-eat-dog world. Everyone wants a piece of the action, and no one wants to lose. That’s impossible.

Today’s technologies make trading faster, sometimes too fast. Markets (e.g., currency pairs) move so quickly that sometime people can barely react.

Moreover, even if they want to react, sometimes it is impossible to do anything. Even trading platforms and trading algorithms can’t execute some trades where they are supposed to. The market simply moves too fast.

As such, the first condition or the starting point to any money management plan is the right mindset.

The right mindset forms when traders know how to embrace loses. Learn how to lose, before you’ll learn how to win.

How many times in a trader’s life will it happen to open a position, only for the market instantly to go in the opposite direction? Too many times.

As such, traders start questioning their decision and doubts shadow the logic behind the trade. The next thing you know, the trade reaches the stop loss. Or, even worse, the trader manually closes it only to see the market reversing sharply.

The right mindset should start with a thing like “shit happens.” It happens in real life, why not in Forex trading.

Therefore, the initial focus should be not to lose, and then focus on making some money. That’s primordial.

Set Realistic Checkpoints

It is OK to want to make a million dollars overnight in Forex trading. But for retail traders, and for others too, a target like this is unrealistic.

Wishful thinking doesn’t work in Forex trading. Nor hope that the market will turn, or prayers for it to do so.

What works is to keep everything under control. That is, to know your human limitations and to understand the market.

The thing is that the market doesn’t move all the time. So traders that want to make a specific amount or number of pips every day, or every week, will have problems from time to time.

What do you think is the natural or rookie reaction when the market doesn’t move for a week or two? The answer is: traders double down on their bets.

As such, the smallest counter swing will take them out. Patience is a virtue, and in trading such virtue is a precious tool.

For realistic targets or checkpoints, use percentages of the trading account. For example, a realistic goal would be to make twenty percent over the next six months.

Or, forty-five percent over the course of a year. Such targets, while generous enough to beat any conventional investing or money-saving strategy, allows for the market to spend time in consolidation too.

Don’t force a trade. If the market doesn’t move, it doesn’t move. Let it come to you, by setting a trading plan, placing pending orders, and staying disciplined.

Use Proper Risk-Reward Ratios

A risk-reward ratio reflects a comparison or balance between the risk of trade and the expected outcome. Naturally, the higher the reward when compared with the risk, the more performant the trade is.

How about a 1:10 risk-reward ratio? It means that for every pip a currency pair moves, the trader gains ten pips.

Or, for every $1 risked, the expected reward is $10. Sounds awesome, right?

Well, while it sounds fantastic, it is simply not possible. Or, unrealistic.

I’m not saying it won’t happen, or such trades don’t exist. But there’s no strategy viable enough to base such ratios on it.

Instead, a realistic or proper risk-reward ratio looks for a two and a half or maximum three pips reward for every pip risked. In other words, 1:2.5 or 1:3 will do the trick in Forex trading.

Why are risk-reward ratios important, you ask? They allow traders to screw up.

Embracing losses, remember? I have no problem taking a hit on a trade if I know that all my trades are subject to a money management plan that follows a 1:3 risk-reward ratio.

In fact, I’m quite confident I won’t lose money after all because such a ratio allows for three losers and only one winner to still break-even.

Not a bad way of thinking is it?

Define the Proper Risk

Numbers have the rare quality of being blunt. Humans might learn a thing or two from the cruel reality that numbers can depict.

Ever wanted to buy a Ferrari? Check your bank account: for ninety-something percent of the people, the numbers in that account say NO. You can’t afford it.

The same in trading. Risk only a percentage of the trading account on ANY given trade.

The account will only benefit. With the implementation of such a disciplined approach, you will be able to afford to be wrong on trade and still make money, and much more.

One or two percent per trade is suitable according to the risk involved in Forex trading.

Conclusion

Before drawing any conclusions from this article, let us refer back to the title. Yes, these are just the basic skills of money management.

Yet, even following such small steps, the traders will end up seeing a difference. The main advantage is that the emotional rollercoaster is left out of the equation.

Moreover, it is ok to fail. As long as failure doesn’t come often, and winners outpace losers, it is part of the plan. The trading plan!

To sum up, trading is a sum of decisions that come and hunt your trading account. Sometimes traders know they are wrong in their analysis. The market makes sure to remind them that, by going against the trade.

Still, they’re unable to cut the loss. Or, to pull the plug.

The inability to jump into action leads to further losses. And, the next thing you know, the trading account disappears.

With money management and disciplined trading, you don’t have to pull the plug. Even if you are wrong, how bad can it get? The stop loss will get hit, alright, but that was part of the overall money management plan, right? Therefore, the stop loss was there in the first place: maybe the market will go against the trade and hit it!

Future articles in this Trading Academy will cover in more details this exciting topic. If anything, this is what traders should master.