Money management in Forex, and it’s importance 💸

117

I’m not a finance professional, don’t take my advice, this article is for entertainment purposes.

In the words of the infamous George Soros, “It’s not whether you’re right or wrong that’s important, it’s how much money you make when you’re right and how much you lose when you’re wrong”.

Forex markets are volatile and risky. There are huge opportunities to profit, and equally huge opportunities to blow your account. Your broker wants you to blow your account.

The “money management” concepts that the gurus feed us hold weight when you look into them.

This piece will highlight some key points you should know; how to use them practically; and hopefully they’ll save you from wasting any more money.

First of all, you need a trading strategy of some sort

You need to build a trading strategy that works a decent percentage of the time. And sadly, there’s no easy way to do grab a magic one. One person’s strategy may not work for another person, because each and every market is different, and viewed at different points in time. Any cure-all magical strategy is either a scam or isn’t shared publically.

You can combat this issue quite easily.

Do a little research, understand basic economics, delve into psychology and crowd mentality, build a foundation in what moves the markets. And, then compound your learning and understand with some technical analysis tools, tools that will give you entry points, tools that are commonly used and will be telling 90% of the market to act in accordance with what you’re about to do.

At the end of the day, if you see the RSI is overbought, no-doubt millions of other trades are thinking “aw hell, this is overbought, better throw money at it“. This comes back to the trading psychology point I just made. The indicator may be bullshit, but markets are erratic, humans are erratic, the purchasing power (or selling power) of the market can easily move prices when the crowd gets an entry signal.

To save tangenting to far away from money-management, now that I’ve scraped the surface on a trading strategy, you need to test your strategy. Money management should be a fundamental part of your strategy.

There are few key things in what I would say make up good money-management.

Don’t over-leverage

Brokers can offer ridiculous leverage on trading products; you can get 100x leverage in some cases.

If you don’t understand what leverage is … the broker essentially loans you money on your “investment” and amplifies your exposure to price moves. For example, if you put £100 down on the GBP/USD, with 100x leverage, you’re actually trading £10,000.

Leverage sounds great because you make more money from price moves, but you should also bear in mind that a 1% move with 100x leverage will wipe your account.

In some cases, a 1% move is a massive move (dependant on the financial instrument), and many brokers are restricted to 30x leverage; but 30x leverage will allow you a 3.3% move before you go broke, yay. However, for many instruments, 1% volatility is nothing.

If you want to use leverage, and want to profit from smaller moves, then make sure you have the margin to back the trade. Set a stop-loss, and cover yourself from blowing your account.

Use your brain, trade where you have a favourable risk-reward ratio

Judging the risk-reward ratio is something that’s difficult to do. But you don’t need to be a financial whiz to spot a good trade.

Let’s say you’ve seen a stock or currency trading within a range for a period of time, and it’s approaching the top of its range – or better yet, its at the top of its range – then placing a stop-loss a few points above the range, and a take-profit nearer the bottom of the range, a distance further than the stop-loss, is a good opportunity the benefit from a positive risk-reward ratio.

Of course, this is very situational, but it’s about the logic behind the trade. If you go into the trade and set your stop loss against the trend; or if you set your take profit 10 pips away and your stop loss 50 pips in the opposite direction; there is a fundamentally stupid trade being opened in these situations.

And don’t trade solely based on the instrument trading in a range, look at different timeframes, make sure longer time frames back your position, and your indicators aren’t telling you the market is about to shove the price in the opposite direction.

Size your positions appropriately; no need to get rich-quicker, you’re already getting rich quick

Compounding earnings look like shit when you’ve only got a £500 balance, any smaller and you’ll be wondering why the hell you’re even doing it. But what you need to recognize is that if you’re pulling a few % every trade, consistently, those earnings will compound. And compound; time and time again.

Position sizing is harder for smaller accounts, but a huge proportion of trades have small accounts. There’s a pretty simple way to get around this, though.

Use the stop loss; if your broker has a minimum position size, and you have to over-leverage, use the damn stop-loss. This way you can control your risk.

And yes, the stop-loss sucks because it’s a guaranteed close; but counteract this with a take profit, that is reasonable, and a few more pips away. Yes, the odds the price hitting your stop-loss in a purely random market are higher, but you have to understand that market isn’t purely random. Honestly, it’s not that random at all.

The market ebbs and flows in trends, and it’s linear enough for us to see patterns and correlations from a quick glance. Pure randomness would make the market akin to white noise, which frankly it isn’t.

Okay, we can’t predict exactly where the market will be at a certain time, but we can predict what market participants might do.

We can predict how people might react when we see a huge red bar emerge, or when we see the RSI cross over the overbought signal, or when the MACD crosses, or when Elon Musk says something crazy on Twitter.

So factor these things into your strategy, and when you feel fairly confident that market is above to move, place a stop loss a little away from where you’re entering, factoring in what people have paid before, and set a take profit at areas that people are likely to start resisting or supporting against your position.

Stop depositing; build your account. If you go broke, re-evaluate, don’t top-up

Everyone in the market loves your deposits. Feed me more, gimme that “gwuala-gwuala”; they’re all thinking it.

The banks grinning and rubbing their chins; the day-traders laughing and banging on their desks; the other punter than just 10x’d his account in a ridiculously leveraged trade, convinced he should trade his life savings in the same manner.

If you’re a bad trader, “more money, more problems”. The only time I’ll use this quote with purpose.

Deposit, trade, manage your money – size appropriately, limit your risk, don’t go fucking crazy and try 5x your balance on a 50 pip move – and then, build your account. Slowly, but surely.

When you go broke, analyze where you fucked up; learn more, read more books, master market psychology; consider whether you’re gambling or trading; and then, only then, consider depositing again.

Learn when to close your trades, or let them run

You need to suss out your style. After all, if you’re trading stocks, with no leverage, and the company has gone to shit but has some potential to come back in a few years time … hell, just leave it! Note, don’t take this as sound financial advice, because it’s not. Obviously, sell shares if they’re going to shit, move into something that isn’t flooring; maybe consider getting back in as the price on the other stock bottoms out.

But, if you’re looking to trade and close out a CFD in a few hours, days, or weeks, close your trade if it’s obviously going against you. But don’t make a habit of this, set your parameters with a stop-loss or a take-profit.

Get control of your emotions

I’m gonna say it, “don’t trade what you can’t afford to lose”. There’s a simple reason for this.

If you need to pay your bills or get your girlfriend an engagement ring, and you trade that money, every penny in the wrong direction is going to make you shit your pants.

And every penny lost will result in you trying to make it back double quick-time, and exposing yourself to more risk. Trust me, I’ve done it, it’s not pretty.

So, put aside a little money, or save up a little fund for trading and be really careful.

  • manage your money
    • don’t over-leverage
    • understand leverage and it’s risks
  • learn about psychology and couple this with the indicators,
  • limit your risk with stop losses
  • set take profits so you don’t have to do it

Good luck.