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Learn the importance of money and risk management in forex trading. Discover how effective money management can significantly improve your chances of becoming a consistently profitable trader.
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“Money and Risk Management” A Critical Component For A Successful Trader
One of the most important aspects of forex trading that many traders seem to be unaware of is that… “They should not expect any particular trade to be a winner or a loser.”
Even if you have a trading strategy that you know has a specific win rate, you still do not know when any given instance of your edge will result in a winning trade or a losing trade.
It’s because in trading, there is a random distribution of winning and losing trades, no matter what your trading edge is.
The critical point here is: It is far more important for you to effectively manage your money than continue to look for a better trading system.
If you don’t fully understand the implications of money management as well as how to actually implement money management techniques, you have a very slim chance of becoming a consistently profitable trader.
Professional risk and money management strategies are the foundation for success.
Basically Risk Management is everything you do before you take a trade Money Management is Everything you do after you take a trade
Risk management is: The difference between success or failure in trading. Trading correctly is 90% money and portfolio management.
Essentially, money management tells you how many lots to trade at a given point.
Money management is a defensive concept: For example, money management tells you whether you have enough new money to trade additional positions.
Unfortunately, this is a fact that most people want to avoid or don’t understand. Once you have your money management under control, your discipline and psychology are 100% of your success.
Issues addressed by money management: • How much capital do you place on each trade? 1% 2% 3%
Issues addressed by money management: • How much capital do you place on each trade? 1% 2% 3% • What is the heat of your trading? If it is the first trade it has more heat or risk … If it is an add on it most likely will have less heat or risk
Issues addressed by money management: • How much capital do you place on each trade? 1% 2% 3% • What is the heat of your trading? If it is the first trade it has more heat or risk … If it is an add on it most likely will have less heat or risk • Capital preservation v. capital appreciation. Setting Stops v. Setting Take Profits
When must you take a loss to avoid larger losses? At your first Stop Loss or sooner… as soon as you see things change on the trade on your management time frame.
When must you take a loss to avoid larger losses? At your first Stop Loss or sooner… as soon as you see things change on the trade on your management time frame. • If you are on a losing streak do you trade the same? NO!
When must you take a loss to avoid larger losses? At your first Stop Loss or sooner… as soon as you see things change on the trade on your management time frame. • If you are on a losing streak do you trade the same? NO! • How you’re trading is adjusted with accumulated new profits. As the account increases you need to increase your lot size to take advantage of additional monies you have to trade with.
How is volatility handled? Do you ride through the volatility or do you get out and wait for a good re-entry?
How is volatility handled? Do you ride through the volatility or do you get out and wait for a good re-entry? How do you prepare yourself psychologically? Have you looked at the lot size you will take? Have you determined how much you will use when you add on to a trade? Do you know how to calculate the most logical place to set your stop loss? Have you determined where you will set your take profits before you start trading?
Have you tested your lot sizing? Opened a demo account about the same size as you will open your live account and put on trades to determine how much your account can handle?
All systems have drawdowns. You can’t have a profitable methodology, without taking some calculated risks as well as some losses.
Risk level among trend followers varies depending upon the size of the profit they seek. For example, if you sought 100% + a year gains, you must be prepared for the possibility of a 30% drawdown.
How much Risk do I take on a trade? Good money management practice is about finding the sweet spot between these undesirable extremes. (Trading to much or not enough)
If you risk little, you win little. If you risk too much, you eventually run to ruin. The optimum, of course, is somewhere in the middle. (not to much and not to little)
Accept too much risk and you increase the odds that you will go bust; Take too little risk and you will not be rewarded in sufficient quantity to beat the overhead of your efforts.
Taking 3 to 5 high probability trades at a time increases the chance of success. If you do have a losing trade then it will only take a small part of your profits and cause very little draw down.
The best place to be is the spot where you can deal with the emotional and financial aspect of drawdown required to get the maximum return.
You need to perform the following important Risk Management chores to do the job properly: • Determine how much you are willing to risk on each trade. • Understand the risk of the trade you are about to take and size the trade • Figure out how much of a draw down you will take before you stop trading for the day
Determining per-trade risk The most important decision you need to make is how much you are willing to risk on each trade relative to your entire port-folio.
A reason to keep this number small is to protect yourself from a series of losses that could bring you to the point of ruin.
The key is to limit those losses so that you can endure a string of them and have enough capital to place trades that will be big winners
Determine how much risk there is in a particular trade A. The first step is to decide — before you put the trade on — at what price you will exit the trade if it goes against you.
Determine how much risk there is in a particular trade A. The first step is to decide — before you put the trade on — at what price you will exit the trade if it goes against you. B. The second is to let money management determine the exit when the “I was wrong” price point is reached.
You need to perform the following important Money Management chores to do the job properly: • Appropriately Track the trade going forward. • Pay attention to your risk points; take small losses before they become big losses. • Review your performance
Tracking your trades It is important to watch your positions as they progress and adjust your stop prices as the market moves in your direction.
A mistake most people make is to consider trade winnings on open “house money” — that somehow this money is less painful to lose than the money in your back pocket.
Pay attention to your risk points; take small losses before they become big losses. …Never move a stop away from its initial price — stops should always be moved to reduce, never increase, the amount of risk on a trade
A money management plan will only be useful if you do what it tells you. This means planning your trades as outlined above and trading your plan.
If a stop price is hit you must take that hit. If you find that your rules are giving you stops that are constantly getting hit, then perhaps you should re-examine your rules—
Take your losses when they are small because if you don’t they are sure to get large. In this regard, discipline is of the highest importance.
It is a cardinal mistake not to take a stop if it is hit. It’s even worse if the trade comes back and turns into a winner because now you have been psychologically rewarded for making the mistake.
Review your performance Get out quickly and re-assess the situation. If you think it will come back, put on a new trade with a new stop.
Risk Reward • Position Sizing • Fixed Dollar vs. Percentage Risk
Risk Reward You need patience to consistently execute a large enough series of trades in order to realize what risk reward can actually do
When we combine the consistent execution of a risk / reward of 1:2, 1:3 or larger (never less than 1:1) with a high-probability trading edge like Trade Grading, you have the recipe for a very potent Forex trading method.
So, risk / reward essentially all boils down to this main point; you have to have the fortitude to takelarge enough series of trades to realize the full power of risk / reward
2. Position Sizing Position sizing is the term given to the process of adjusting the number of lots you trade to meet your pre-determined risk amount and stop loss distance.
Position Sizing (just one method) $3000 Account x 1% = $30 2% = $60 Standard account it would be 0.2 lot trade Mini account it would be 2.0 lot trade You want to trade 2 mini lots or $1 per lot or $2 for each pip. Your stop would be 15 pips. Could you take the following trade?
