Money management plays a key role in Forex trading, and you need special techniques to do so. If the traders don’t acquire the proper skills for money management and risk, trading will be just like gambling for them, and the results of their trades will be unknown. Mastering money management in the financial markets will show you the difference between a professional and an amateur trader. Here, we’re about to talk about notes and principles related to Forex money management to help you see a general picture of this topic and gain the needed skills.
Forex Money Management in a Simple Word
Money management is simply a set of actions that help us increase our profits while trading and don’t let us lose our capital. These actions must be planned, purposeful, and follow certain rules. The basic role of Forex money management is to maintain the main capital. The sole purpose of money management is to minimize trading losses, and even if the trader loses money, this won’t be a barrier for other trades to make profits.
Why Is Forex Money Management Important?
If you check out the Forex training websites and, overall, the general atmosphere of the internet, you’ll see that most resources dedicate their contents to teaching technical or fundamental analysis. But you don’t see many resources that teach money management, and this proves that mastering money management is an important factor in distinguishing traders. In fact, knowledge and money management skills are the two key factors that let you succeed in financial markets. Here, we only consider one of them.
Money Management Techniques
Being inexperienced and ignoring money management principles increases risk and decreases profit. This important issue caused traders to lose their money in the Forex market. If the traders acquire the proper skills for money management and learn the principles, they easily manage their capital in the Forex market.
Increase Your Knowledge
The most important and evident step to learning money management principles is to increase your knowledge in the financial markets sphere. The Forex is a vast market, and you need to understand it to have profitable trades. Market analysis is one of the base requisites of trading in the Forex market.
Generally, there are two types of analysis: technical and fundamental. The first one shows you the price charts, and the second one offers fundamental analysis, such as economic analysis and news of the world. Mastering these two analyses increases your skill in managing your money in the Forex market.
Determine Your Risk Level
One of the common mistakes of new traders is that they don’t determine their risk level for each trade. You must determine a certain amount of risk to gain a certain amount of profit for each trade. The professionals believe you should only risk 2 or 3 percent of your capital.
For example, if someone has 10,000 dollars in his bank account, he needs to risk 2 percent of it, which means 200 dollars. This amount is suitable to begin each trade. If the trader loses money on that trade, he still has enough capital to start a new one. To start trading in Forex, risk your money on trades with low positions and then increase your trading account over time.
Trade with the Amount of Money You Can Afford to Lose
Sometimes, your emotions get mixed up with your Forex trading. If you don’t control your emotions, this can lead to a wrong decision. Many traders behave based on their emotions while trading and use a huge amount of their capital for a certain trade. If the position doesn’t go as expected, the Forex trader will lose a lot of money. Worse than that, the trader will not be able to trade anymore to compensate for the damage.
The Forex money management formula is to control your temporary emotions and excitements. An experienced trader knows that people shouldn’t put all their eggs in one basket. Therefore, determine a certain amount for any trade. This way, if you lose that money, you can compensate for that amount.
Don’t Risk All of Your Money
One of the biggest mistakes new traders may make is risking a huge amount of their capital, and in some cases, all of it. The lack of emotional control, risk management and, sometimes, greediness can put traders in big trouble. Therefore, the best decision is to act reasonably and maintain a certain amount of your capital and trade with the rest.
Another thing that you should consider having is a risk limit. If the trader is unable to compensate for the loss in every trade, he will leave the market over time and lose all of his money.
Don’t Trade Too Much in Forex
Some people believe that if they trade every day and at every hour, they will gain more profits. But his action is called Over-trade. And it means you’re trading too much. Every trader has his own method and follows certain signals. As long as you don’t receive these signals from the market, you shouldn’t trade at all. One of the principles that every professional trader should follow in Forex money management is being patient and having principles.
Determine When You Should Close a Position Before Trading
Another principle for managing money in Forex is determining your exit time before even starting trading. Every professional trader analyses the situation before trading and is aware of the situation. Also, the trader knows about the outlook of each trade and what is the right time to position a trade, have profit, and Stop Loss.
These traders have a time limitation for some trades and determine their exit time. It means that if the trader doesn’t have a profit for a certain amount of time, they close the position.
Emotional Management
Money management is not solely dependent on financial literacy and technical skills. It also requires that you manage your emotions because financial markets are extremely volatile, and they may cause several ups and downs for us. A professional trader knows that each trade, regardless of all the predictions, can go wrong and makes you lose money or maybe some unexpected incidents happen in the market. Therefore, controlling your emotions and not deciding based on excitement is one of the most important principles of money management.
Learn How to Determine the Stop Loss and Take Profit
Stop Loss and Take Profit enables traders to manage their trade. One of the tricks you need to know is that professional traders recognize the losing trades immediately and close them. However amateur traders wait and hope their positions become profitable, and they lose more money. This depends on whether you recognize the losing trades.
Although being patient is necessary for trading, this factor may work against you in losing trades. That’s why you should limit your losses and increase your profits. Traders determine Stop Loss and Take Profit to manage their trades skillfully. Practice this mechanism in small positions and prepare yourself to act better in larger positions.
Always Use Stop Loss
You can say that Stop Loss is a money management strategy in Forex, and professional traders use it nonstop. Stop Loss means that when the price of the position reaches a certain amount you determined, it closes automatically and doesn’t let you lose money. Therefore, you need to Stop Loss for every trade.
Optimize the Risk-Reward Ratio
Risk-reward ratio means that for every amount a trader risks, he gains a reward. The ideal ratio for traders is 3:1, although some traders also use other ratios.
Be Aware of the Leverage
Leverage is a capability that traders use to increase their profits and losses. Each broker offers a specific amount of leverage to traders, but new investors should always start with a lower amount of leverage to decrease the possibility of losing money.
Pay Attention to Currency Correlation
Currency correlation is the relationship between two currencies. It means that if two currencies have a positive relationship, both go in the same direction. Your duty as an investor is to recognize these currency correlations because when two currencies go in the same direction, they neutralize each other, and investing in them is pointless.
Keep the risk Level Steady
One of the traps that new traders fall into is increasing their position in profitable trades. When they start making a profit, they become encouraged to increase the number of positions. But if they don’t identify that it is a losing trade or a winning trade, they may lose money. Therefore, setting the risk level is one of the principles of Forex money management. Set it to 3 percent for daily trades.
Become a Long Term Thinker
The success and failure of trades are measured by their long-term result. Therefore, don’t jeopardize your future success for the success or failure of today. Always make sure to check out the Forex economic calendar and be aware of news for the strategies and money management of your future trades.
What Are the Benefits of Money Management?
Besides the benefits we mentioned above, money management has many side benefits, such as:
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Financial Security
There is no doubt that the proper management of money gives us continual financial security. As a trader, if you have good money management in Forex, you’ll always experience a continuous upward trend in this market. Don’t forget that maintaining the capital is the key factor. Always keep some of the capital or liquidity for future trades to always have enough money for future opportunities.
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It Prevents huge financial loss
If you want to have the right perception of money management, you have to act like a professional. Professional behavior does not come from destructive emotions such as anger, excitement, greed, etc. Controlling these emotions prevents financial loss and helps us to choose the right positions in the market. It’s worth mentioning that knowledge and enough experience are also necessary to avoid wrong decisions, and controlling emotions is not enough.
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It Reduces psychological stress
When we know which strategy to choose to manage our money, we will have a lower level of stress. Confusion and uncertainty are the main reasons for stress, and they may force traders to enter many pointless positions. Choosing the proper money management with the principles mentioned will reduce your stress level significantly.
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It Makes the Trades Profitable
The more you increase your Forex money management skills, the better your trades will be, and you will gain more profits. Mastering fundamental and technical analysis helps you to understand the market better and choose more profitable positions.
Final Words
Money management includes every action and skill that results in preserving your capital, decreasing the chance for financial loss, and helping you gain more profits. We talked about Forex money management in this article thoroughly and explained the benefits of doing so. In general, for money management, you need to have enough knowledge, know the market, manage your emotions, have a risk limit, Stop Loss, and Take Profit. All these factors combined help you to have a proper trading trend gain more profits and add to your capital.