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The foreign exchange market holds the remarkable position of being the world’s largest financial market. Prior to the advent of online forex brokers that brought forex trading to the masses, this huge market had largely been the trading domain of large financial institutions, corporations and high net worth individuals.
As interest in the currency market has quite recently expanded into the retail sector, the need for educating novice traders on the use of appropriate risk and money management tactics has also grown substantially. The benefits of learning about and applying the well-established methods of protecting one’s trading capital are considerable since they can really make the difference between a successful forex trader and one that quickly sees their trading account funds disappear.
The proper application of money management gives a forex trader an account growth edge, while trading forex without a logical money management strategy typically amounts to little more than gambling. This explains why forex risk and money management practices remain an essential part of the business that needs to be incorporated into every forex trading plan. In fact, the main reason why novice forex traders fail to grow their trading accounts is due to their lack of understanding or failure to apply proven money management principles to their trading endeavors.
Accordingly, proper risk and money management techniques need to be understood and consistently practiced by any forex trader who wants to grow their trading account and remain in the currency trading business over the long term.
The following sections of this article will introduce basic money and risk management concepts. They will also discuss some of the more popular techniques for managing risk and money when trading currencies, as well as some of the tools traders commonly employ when doing so.
For forex traders, the goal of money management is to maximize profitability and minimize losses while conserving trading capital, while the overall purpose of risk management is to make sure that various uncertain elements in the trading environment do not derail their chances of profitability and other measures of success in their currency trading business.
Risk management in forex trading is a rather broad concept. In essence, forex risk management involves identifying, assessing and prioritizingand then engaging in the use of resources to minimize, control and monitor the chances and/or effect of adverse events, such as trading losses, and to maximize the chances and/or effect of favorable events, such as trading gains.
Money management in trading currencies should be a key part of a forex trader’s overall risk management strategy. As the name implies, forex money management involves consistently using one or more strategic techniques to make a currency trader’s risk capital yield the highest return for any losses that might be incurred in the process. Money management revolves around the basic idea of conserving trading capital or money by effectively managing the numerous financial risks your forex trading account is exposed to.
Trading successfully in the forex market typically means growing yourby wisely managing profits and losses using a sound forex money management strategy.
Although wisdom typically grows with experience, most currency traders would tend to agree that profits taken should typically be larger than losses taken, which is the essence of the old adage that advises traders to “cut losses short and let profits run”.
Ideally, every forex trader looking to grow their trading account should be using a forex money management system contained within a trading plan that objectively lays out their goals and how they intend to manage their trading activities. Of course, the actual details of each trading plan will differ according to each individual trader’s personality, choices and preferences, but every such trading plan should lay out the money management techniques the trader creating it intends to use.
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Although some common money management techniques might limit the profits a trade might potentially make, their use as part of an overall money management plan are some of the best practices a forex trader can employ to remain consistently profitable overall. After all, the forex market can be quite volatile at times, so having a detailed set of forex money management rules allow you to know in advance how you intend to size a position, limit losses and take profits.
Incorporating money management techniques into your trading plan might take a bit of trial and error to see what works best for your trading strategy, account size and risk tolerance.
Of course, any trading plan is only as good as the discipline a trader can muster in sticking to it. Quite simply, you should make sure you plan the trade, and trade the plan.
As a good place to start, some of the more established guidelines for money management include the following:
Many forex traders who have incorporated some or all of the best money management practices listed above into their trading plans will use or develop various money management tools to help them compute positions sizes and risk for each potential trade they plan to take.
Although some online forexare available, traders who are familiar with the use of Microsoft’s Excel or another similar spreadsheet program can readily create their own software tools for this purpose and can customize them to their specific trading needs.
For example, a typical money management calculator you can easily create in a spreadsheet might help you to determine what position size to take in a particular currency pair based on the amount of funds in your account and the amount of money or percent of your account you want to risk on the trade.
A money management tool like this might have the following parameters as inputs:
The outputs of the calculator could then include the position size you should take, as well as the number of pips you are risking and anticipating as profit on the trade and what that means in terms of profit or loss to your trading account expressed in your base currency.
When trading currencies, risk management involves identifying potential risks, assessing the probabilities of them occurring, and then taking steps to avoid them.
Risk management might also include mitigating any damage to your trading account, ability to trade, lifestyle and relationships if an anticipated risk eventually becomes a reality.
The various money management strategies discussed above are an important element of risk management that focus largely on possible market movements, position sizing and their potential trading account impact.
Nevertheless, not all of a trader’s risk management strategies will be solely related to market or account risk, since various other types of risk can impact a forex trader’s overall business.
For this reason, traders will often incorporate some additional risk management strategies into their forex trading plan.
Each trader should evaluate these additional risks that are most applicable to their situation and take necessary step to minimize them.
Some additional components of trading related risk and how to manage them into a forex trading plan appear below:
In conclusion, the various risks involved in running a forex trading business need to be monitored, managed and mitigated. Research shows that having a suitable forex risk management plan that includes sound money management practices can greatly increase your chances of becoming a successful forex trader over the long term.