The Importance of Money Management in Forex Trading

Filed under: Learn Forex Trading |

One of the most overlooked aspects of forex trading by non-professional traders is money management. Traders often get bogged down in complicated technical indicators and systems and overlook the foundation on which all successful trading accounts are based – money management. Without a stringent set of money management rules, one can easily blow ones account up even if your trading methods are sound. So what does good money management entail?

Trading gurus such as Alexander Elder believe that traders should never risk more than 2% of their account on any one trade. However, it should be noted that this risk level is a MAXIMUM risk level, and most professionals use a much lower exposure limit, sometimes as low as 0.5%. What a 2% risk level means is that you can lose fifty trades in a row before your account blows up, which is highly unlikely even if you are making random trades. However, this is only the first step of good money management.

Another factor to consider is the risk-reward scenario. Traders such as Steve Nison and Nial Fuller advocate the use of a strong risk-reward scenario, whereby the risk is always at least half  of what the reward might be. For example, if you are risking 2% of a $10,000 account ($200), then your reward might be $400, which is a risk-reward ratio of 1:2. You could also use a risk reward scenario of 1:3,1:4, or even 1:5 if the market is favourable, but you must have logical targets, otherwise the trade should not be considered. By using this risk-reward strategy, you can in effect lose on over half of your trades and still make good profits.

So in conclusion, money management is a key ingredient of any trader’s trading strategy, and those who neglect it will inevitably find themselves in trouble. It is therefore important to decide on your own personal risk threshold, and implement your level consistently. If you do, then you have every chance of being a successful forex trader.

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