Capital management is one of the most undervalued aspects of trading in financial markets. You can find hundreds of different strategies in the internet, notes on the topic of psychology with the urge to “Do not be scared!”, but there are very small of really quality materials about risk management.
But even the existing information is very incomplete and vague, it does not give a clear understanding of what needs to be done, how and why.
I decided to write an article that will reveal the importance and role of money management, the main nuances of risk management, describe various risk management systems, and also tell what system I use, in detail and absolutely free of charge because of the lack of normal material in the web.
What is Money Management and Its Role in Trading?
Money management (MM) is a system of rules that helps a trader to effectively manage his capital to ensure stability in trading and avoid large losses in case of a losing trade/period. Money management is an integral and most important part of the trader’s trading system. The ability to manage risks distinguishes an amateur from a professional and multiplies your chances of a positive trade outcome.
It is because of the lack of competent and strict management risk that 97% of traders LOSE their money. It is the risk management that will save you from a full drain when you have a series of failures. It is risk management that helps to stabilize your trading and become a real professional. And it is money management that will help you to overcome your psychological difficulties.
Risk management serves you as a shield against any situation in Forex and should become your best friend if you want to succeed in trading.
Balanced and thoughtful money management will help you to defeat your emotions, especially fear and greed. Gives you peace of mind and confidence in your own strength, which will positively affect your trade.
Therefore, if you do not have a clear mechanism for managing capital, I strongly recommend that you develop it, paying attention to the information that will be outlined in this article.
General Rules of Trading in the Forex Market
Before disassembling certain management systems, it is necessary to pay attention to the basic rules of trading, which indirectly relate to management and risk management.
Below you will find a list of activities that will make life easier for you during trading and protect against various risks and unforeseen situations. All items are written in the money of those who violated them. Therefore, I strongly recommend not to violate these rules and not to invent a bicycle – this will save you money and nerves.
- Before entering into a deal, answer 3 questions before you: Why do I enter into a deal? Where do I put the stop loss? Where will I close the profit? If you do not know the answer to at least one question, it is better not to enter the deal. More money will be more valuable.
- Accurately stick to your trading system. Disconnect emotions during trading. They are your worst enemies. You must be concentrated and cool. Discipline is your best friend.
- Do not trade, if you, because of some event, overwhelm emotions or feelings, whether good or bad. During trading, you should only think about the market and not be distracted by extraneous matters. Also avoid bidding if there’s fuss around you and it’s hard for you to concentrate.
- Try to trade on the trend. Do not try to catch a market turn. Very often this leads to unprofitable positions.
- Always trade with a stop loss. Often I hear, especially from beginners, that the stop loss takes some of their profits, and if it were not for the stop loss, they would have earned. After that, they start trading without stops … until the first discharge. After all, sooner or later the price will not turn in their direction, but will go further, which will lead to a complete loss of money. Unfortunately, many learn only on their lost money.
- Never and under no circumstances take a loan or loan for trading on Forex. Trading is a very risky business and no one can ever be 100% sure that he will not lose part or all of his money. Trade only for money, the loss of which will not affect the welfare of you and your family!
- Try to trade with the mathematical expectation of a stop loss to take profit, a minimum of 1 to 2, or better 1 to 3 and higher. Do not try to take 5 points of profit with a stop of 20 points. This is silly. In the end, during a bad period (they happen to everyone), you simply lose money. It is a positive mathematical expectation that is the key to your long-term success.
- Do not trade before the news and during the news. This is the most attractive type of trade, as you can earn a large percentage of your deposit in a short time. Unfortunately, practice shows that virtually everyone who trades on the news merge, because the risks are unrealistically overstated + many brokers do not like news trading and put the sticks in the wheel. Moreover, before the release of important macroeconomic news, it is better to liquidate open positions, so as not to risk another risk.
- Do not open several positions at the same time on highly correlated instruments, otherwise you overstate the risk and can get an increased loss. Try to distribute the risk between different groups of instruments, in which case it is likely that at least some of the transactions will come, and you will get profit (unless of course you conclude transactions with a mathematical expectation of profit 1 to 3). Also, do not open too many positions at the same time. 3-4 positions of full volume for different instruments will be enough for a good earning.
- Do not average! Do not build the illusion that the market is about to unfold. Even if you are lucky, sooner or later you will get a full discharge or drawdown of 50% +. You can only add to a profitable position and if there is a good opportunity for this.
- Do not move the stop-loss. The situation is very similar to the previous paragraph. Do not expect that the price is about to turn around and go in your direction. Thus, you overestimate the risk and more often lose more than you should have. Stop can only be moved in the direction of the price. But do not too soon move the stop in breakeven, otherwise you can lose some of your potential profits. Allow the profits to grow.
- Do not put the stop loss in obvious places. Very often such stops are demolished and after that the price goes to your side, but without you. Footsteps should be set for levels whose breakout completely cancels your scenario of market movement.
- After a series of losing trades, rest, distract, to relieve the emotional tension. To trading it is worth returning only to how you calm down and take a breath.
- Do not try to recoup after an unsuccessful deal (-s). This point is closely related to paragraph 13. If you feel that after losing a profit you are filled with emotions, it is better to leave the trade for a while. Very often, traders lose even more by trying to “get back” their money.
- Do not use locks if you do not have enough experience for this. A lock is just an illusion of security, because the price can go very far from the castle and then part of your deposit will “hang.” Such are the “dead” locks very often heavily pressure on the psyche, which prevents adequately assess the situation and make informed decisions.
- Do not trade before closing trades on Friday evening. Very often at this time, many market players are out of position and the price may behave inadequately.
- Try not to leave the position for the weekend. After the weekend, the price can be opened by gepom, so you can, as a loss of profit, and get a stop with a “reserve” and lose more than planned.
- Always have an alternative method of managing transactions. For example, a phone, a tablet, etc. In life, different things happen, and it will be very annoying if you suddenly turn off the light or the Internet, and you do not have an additional way to close the open transactions.
- Analyze your transactions. This especially applies to beginners. Pay special attention to the most profitable trades and deals that closed on the stop. Self-analysis and improvement is the key to success in trading.
- Work on yourself. Markets are changing, so are you. Read, communicate, learn new information, you never know what can come in handy sooner or later.
Money Management Systems and Their Comparison
In this section, we will review the most popular and used risk management systems.
All Deposit Trading
The essence of the method: in each transaction you enter the maximum possible number of lots. Usually a large leverage is needed for such a system.
Advantages: the maximum possible profit, as you come off the maximum volume. Often such a system is used to disperse the deposit. Very popular with beginners and “players”, allows you to “raise” the deposit and feel the excitement of the “game”.
Disadvantages: Where the maximum profit, there is a maximum drawdown. The reverse side of the big leverage, you can lose everything as quickly as you earn. The most risky management system.
The bottom line: I strongly advise against using this method of risk management. The trade in all of the capital is directly bordered by a complete loss of the deposit and is peculiar only to inexperienced traders and gamblers.
Trading by Fixed Lot
The essence of the method: all transactions are opened with the same lot (0.03, 0.1, 2.5 lots, etc.) regardless of the size of the deposit, the outcome of the previous transaction and other indicators. Also there is a modified version of this system, when the lot is increased after passing a deposit a certain mark (the so-called “stepped” fixed lot).
Advantages: the most simple in understanding risk management system. You simply choose the lot size and constantly trade it.
Disadvantages: lack of flexibility and reaction to changing the deposit (especially in the basic version). With a decrease in the deposit, trading a fixed lot will overstate the risks, with an increase in the deposit, decrease, which in turn will reduce profitability.
The bottom line: a good capital management system for beginners, but in the future it is desirable to switch to a more flexible method.
The essence of the method: in each transaction we risk a certain, fixed% of the deposit. Example calculation: we have a deposit of $ 2000. We decided in each transaction to risk no more than 2%. Accordingly, our risk = $ 40.
Our trading system shows us a potential deal with a stop loss of 80 points. We calculate the size of stop loss for our transaction based on the volume of 0.01. If our transaction on the EUR / USD currency pair (the price of the item is 10 cents), then $ 0.10 * 80 = $ 8. After that, we divide $ 40 into $ 8 and get 5. Accordingly, we can open 5 deals for 0.01 lot or one for 0.05 lots, which is more logical.
If you have a transaction in another currency or instrument, you can use the point calculator for more accurate calculations.
Advantages: a fairly simple risk management system, the volume of transactions increases in proportion to the size of the deposit, i.e. the risk constantly remains unchanged.
Disadvantages: from the disadvantages is to highlight the effect of the “asymmetric” lever. In order to work out a certain loss or drawdown, it is necessary to take a large number of points, as the volume of transactions will decrease after a decrease in the deposit. On the other hand, this approach will not allow you to drain all the money even in hard times.
The bottom line: the optimal system that allows your trading system to adequately react to changing the size of funds on the account and prevents large drawdowns.
In addition to these risk management methods, it is possible to distinguish systems of optimal interest, safe interest and fixed proportions, but they are a hybrid of the basic systems listed above. Therefore, there is no point in disassembling them in detail.
What system to use to choose only you, on the Internet you can find even more systems, but one way or another, they are all derived from the three above-mentioned basic methods.
Personally, I use a fixed-interest system. For all time it has proved its efficiency and reliability.
Finally I want to share the nuances that I use:
- All transactions of the same size in money terms, this is very important, do not forget about it. If you can not calculate the integer number of volume, take a little less;
- Do not take more than 5% risk per 1 transaction. I take 1%, and I take the maximum risk per basket (several positions on non-correlating instruments) 4-5%. Those. more than 4-5 transactions at the same time I have not opened.
- I distribute the basket of transactions as follows: 1% for currencies (metals); 2% for goods (energy and agricultural products); 1% on indices, 1% on bonds. If you have a deal open, for example, in currency, and it is already well developed, you can put a stop in used and open another transaction in currency or gold. Thus, you do not overestimate the risk, because deal in used automatically free-of-charge.
- The ratio of stop to take profit 1 to 3. Once again, I remind you of a positive expectation mate. This is a very important aspect of trade in general, and the proper operation of this management system in particular.
- I do not set take profits. At all! Very often there are situations that the price does not stop on reaching our intended goals, but goes on. Thus it turns out to take transactions with mat expectation of 1 to 5, 1 to 10 or more. Once again I repeat, let’s profit to grow! If you need to leave the terminal, you either close the position, or watch it on your phone, tablet, etc.
- Never rush to put in second-hand. Very often we lose profit from what was moved to breakeven, although the price just once again tested the level (for example). Do not move the stop loss in the direction of the price without good reason.
These are my personal “things” that I use every day. I advise you, at least, to analyze them and take them into account.
What kind of risk management system do you use? Answers write in the comments below.
If you have any questions or difficulties on this topic, write to me in Skype – vovkfx, I’ll be happy to help.
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