Why money management matters in forex trading

why-money-management-matters-in-forex-trading

Whether this is because they lack knowledge or they simply do not wish to waste any of their time, many Forex traders tend not to pay enough attention to money management.

No matter the case, investors need to know that overlooking proper bankroll management will inevitably have a detrimental effect on their results, and paying lip service to it is certainly not enough.

Having extensive knowledge will not do much, neither will trading strategies if investors do not know what to do in order to protect their balance, minimize the losses, and grow it further.

Therefore, one of the quickest and the best ways to tell successful Forex traders from the rest of the investors is to ask them if they use money management. Why it is so important and what bankroll management is are just some of the questions we will answer in this article.

The Importance of Money Management in Forex Trading

Contrary to what most traders believe, being a successful trader is not all about having thorough knowledge as proper bankroll management is just as important. In essence, many investors think that bankroll management and risk management are two interchangeable terms that are used to describe one and the same thing. Yet, this is not so as risk management has to do with the risk traders should watch out for and cope with, while bankroll management has to do with the protection of their funds.

So what money management in Forex trading is all about? In simple terms, bankroll management can be described as a set of self-imposed rules traders have come up with and stick to in order to achieve the goals they have set. The main purposes of these rules are to ensure that the bankroll of traders will endure, and hopefully, they will reach the point at which it will start growing.

According to trading pedia, becoming a profitable Forex trader is by no means a walk in the park, and the first thing you should take into account is that trading more than you can afford is ill-advised. Despite the fact that this piece of advice might seem to you rather obvious, investors often overlook it, and tend to load their accounts with more money than they can afford to use.

The best thing you can do to ensure that you will not lose capital you need is to set a monthly loss limit, and once you hit it, you will need to give up on trading for now. Something essential even experienced investors often overlook is that Forex trading is not a guaranteed money-maker, and losing money is something they should be prepared for.

Cashing out their profit is one more thing many traders do not pay enough heed to. If you see that the amount in your trading accounts continues to increase, just withdraw your profit, as if you choose to leave it there, you will be more prone to trade with it and ultimately lose it.

Another thing traders are advised to do when they are looking to improve their results is to evaluate the risk per trade. Although it might sound a bit confusing at first, this means that they should pick an amount they will put on a trade, and most importantly, they should decide on the criterion they will be guided by while making up their minds. Depending on their preferences, traders might be more comfortable with picking a fixed amount, while others might opt for a fixed percentage.

Choosing the amount investors will risk per trade is just as important as deciding on the take profit. While choosing their profit target, traders should take into account their goals, profile, as well as the strategy they are making use of. The best way for traders to determine their risk to reward ratio is to take into account their maximum acceptable loss.

Types of Stops

If you have already understood the importance of bankroll management and you are ready to go ahead with your trades, you should also pay closer attention to the different types of stops to take advantage of.

The first and the most straightforward one is the equity stop. Using this stop means that investors will decide in advance what portion of their balance they will use on a single trade. Investors will have the freedom to decide on the amount they will risk on a single trade based on their style, the size of their bankroll, and of course, the goals they have set. Yet, most experts recommend not to go over the 2% threshold.

Another strategy, which some traders prefer using is the margin stop. Yet, it does not enjoy such overwhelming popularity as the above-mentioned because it is slightly more complex. Making use of it involves dividing your entire bankroll into ten equal-sized units. Normally, the leverage most brokers will offer is 100:1, and if we assume that the investor has chosen to put $1,000 on a particular trade, this will mean that the unit lot the investor will be able to control is 100,000. Yet, a margin call will be triggered, no matter what the point move against the trader is.

The chart stop is another stop investors can take advantage of. As far as technical analysis is concerned, you might already be aware that the stops can be generated by technical indicator signals or by the price action of the charts. Thus, the high/low swing can serve as a prime example of a chart stop.

Finally, investors can use volatility stops that are a higher-risk variant of the chart stops. Yet, the most significant difference between the two is that the risk parameters are set using volatility. One of the most widespread ways of measuring volatility in prices is using the technical analysis tool called Bollinger Band.

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