money management
MONEY MANAGEMENT
Most beginning traders believe that a good entry into the market is the key to success. Unfortunately most are very wrong. Money Management is by far the most important criteria of trading, whether it’s stocks, futures or FOREX. Every successful trader will agree that managing your trades correctly is the #1 key to consistent profits.
Loosing a trade or several trades in a row is just part of trading, period! Having a plan and trading your plan is key to consistent successful results in trading, your trading strategy will help you recognize entry and exit points in the market; while most traders trade on the side of probabilities when entering into a position. Unfortunately, markets move in unpredictable ways at times and even the best traders are not always on the side of the move. In fact, many professional traders are right less then 50% of the time. Now, I can hear most of you saying to yourselves, “how can they make money if they are profitable less then 50% of the time”? It’s really very simple, Money Management! You see if you’re able to effectively manage your money you only need to be right about 50% of the time. The unfortunate thing about most of traders is that there primary focus tends to always be on making money and not protecting what they currently have. You see, you have a 50 / 50 chance of the market going your way by just flipping a coin. But let’s say you flip a coin and Heads you BUY and Tails you SELL. Once you have made your entry into the market you need to protect your position in the event your flip of the coin goes against you. Let’s assume for each $10,000 we use to control a position that we are only willing to loose $200.00 or 2%. Now we’ll also assume that for every trade you enter you expect to make at least twice what you’re willing to loose $400 or 4% and we’ll assume you have made a total of 10 trades, 5 winners and 5 losers.
Sample Trade log. (Hypothetical of course)
1. Buy USD / JPY ($200.00)
2. Sell GBP/USD ($200.00)
3. Buy USD/CHF +$400.00
4. Sell EUR/USD ($200.00)
5. Sell USD/JPY +400.00
6. Buy EUR/USD +400.00
7. Buy USD/CHF +400.00
8. Sell GBP/USD ($200.00)
9. Buy USD/JPY ($200.00)
10. Sell EUR/USD +$400.00
Net Profits $1,000.00
Can you start to see the importance of good money management in your trading plan? Sure you can, but most people have a real emotional tie to their money. It’s important to follow the rules associated with managing your trades for consistent profits. Setting a Stop Loss to protect your account is the first primary rule in trading (protect your profits.) Each time you enter into a trade have your Stop Loss point already set in your head and immediately set it on your trading screen.
Using a Stop Loss is only part of what your Money Management Strategy should be, but it is also a very important part. A Stop Loss is a form of insurance that you’ll be able to continue to trade by minimizing your losses in the event you’re wrong. It’s insurance for the trader.
Money management RULE #1 is to NEVER, EVER, EVER TRADE WITHOUT A STOP LOSS.
Now placing a stop loss is of course very important but placing a proper stop loss is very important too. By this I mean, always be aware of what your Risk Reward Ratio is and where your levels of support and resistance are. If you want to make $400.00 but are only willing to risk $200.00, then your risk reward ratio is 1 to 2. Let’s say you want to be even more conservative and trade only a ½ to 1 Risk Reward Ratio. Now on the example above you would have only netted $500.00 but you still netted $500.00! On a $10,000 account that is 5% of your balance. 10 trades in FOREX could simply be 1 trade per day Monday through Friday for 2 weeks. If you completed this for 4 weeks then you’re looking at 10% on your money in 4 week (or 1 month). Now I’ve been around for a long time and I’ve never seen a Bank pay me 10% on my money for 4 weeks! Now at a 1 to 2 Risk to Reward Ratio we would be looking at 20% in 1 month with out compounding.
Money Management Rule #2, always trade with a Risk Reward Ratio of 1 to 2 or better on every trade.
Leverage is another key to making money in the FOREX. No other market in the world that I know of allows the leverage that we see in the FOREX. 100 to 1 leverage is the normal fee that most Brokerages allow investors to trade with in a standard account.An example is this; for each $1,000 that you put up allows you to control $100,000 worth of currency! Think about that for a moment, it’s really incredible! That's like them lending you $99,000 dollars. This huge leverage is what allows us to make the kind of returns that the FOREX allows. But, it also enables us to loose some or all of our money if we trade foolishly. Leverage is a wonderful money making tool but when abused it can lead to financial destruction as well. Think about consumer credit cards for example. The bank lets you borrow large sums of money on your word that you’ll pay it back, but when credit is abused, it can lead to bankruptcy for many. So just like managing your credit debt you need to manage your trading leverage. Most people would not go out and rack up huge debt that they knew they could not pay because it would not be responsible, right. Well, when trading the FOREX if you started with a $10,000 account should you start by trading 10 lots? No, that would be foolish. A very conservative yet very effective method of trading is to never leverage more than 5% of your account on any 1 trade. With the example we used above, you could quickly grow your account to a very large amount in a relatively short amount of time. The compounding factor of money is a very powerful thing yet due to most peoples desire to get rich quick and take unnecessary risks, they tend to focus more on the dollar signs than on proper trading principles. If you truly want to make consistent profits and make exceptional returns on your hard earned money, take it from some one who’s been there, follow these simple but effective Money Management rules. A good rule of thumb is to keep your leverage at 5% or less. Your not able to make huge money, as the position sizes are only 1 10th of a standard account but the percentage of returns will quickly allow you to start trading larger sums of money and in the end will allow you the success you seek.
Money Management Rule #3, never over leverage your account.
Making realistic goals is another key factor to trading success. Don’t expect to make a living trading right from the start. There is a learning process that every trader goes through to become successful. Not only learning to enter and exit trades correctly, but also the process of controlling one's emotions. Many traders make ridiculous monetary goals when they first start trading. Make a simple goal to get consistent returns on your account each month. Have a plan and stick to it your plan; trade your strategy and the rewards will typically surprise you.
Money Management Rule #4, make realistic goals that can be achieved within reason.
Emotions and money do not mix. Simply treat each trade as a business transaction and don’t get emotionally attached to a trade. Take your losses and move on. Learning how to loose is probably more important than winning. Why, because a new trader will typically take their first loss and wonder what they did wrong, and then sit on the side-lines and let all the profitable trades go by. Discipline is another key factor in trading that tends to be a learned trait that takes a bit of time to get used too. So, accept your losses and move on. Trust your trading plan and trading strategy, as your analysis usually correct.
Money Management Rule #5, accept your losses, move onto the next trade.
Protecting your profits is another factor that helps insure consistent profits. If you’re a longer-term trader such as a Swing Trader or Position Trader, it is important to protect your profits by adjusting your stops to secure profits as you reach your profit targets in accordance with support or resistance levels. An example; lets say your taking a long position (Buying) the USD/JPY with resistance 100 PIPs away giving us a 100 PIP target with support 30 PIPs below our entry point this gives us a 1 to 3.3 risk to reward ratio if we are risking 2% of our 10,000 account balance or ($200) then we could place a trade with 6 lots (rounding down) this way our maxim draw down for this position will be just under our 2% risk tolerance. With our current risk to reward ration of 1 to 3.3 we are projecting to make just over 3% on our position or ($600.) during the course of our trade the market will follow the overall trend creating (higher highs) and smaller pullbacks or higher lows also known as the (imbedded trend.) As we follow our trade and make adjustments to our position we look to adjust our stops when price continues on the over all trend or breaks the higher high. We will adjust our stop just below the higher low or the (imbedded trend.) This now serves as a new level of support or (sub level of support) after price pulls back creating the higher low or imbedded this is now new support. This will minimize the risk to your account while still following the overall trend and adjusting our trade in accordance to technical levels of support or resistance. More advanced methods of Stop Loss Trailing can be covered with your continuing education.
Money Management Rule #6, protect your profits when your position is profitable.
Trading with money you cannot afford to loose is a very foolish thing to do, yet it is common among the beginning trader. When trading, be sure to trade only with money that will not affect your lifestyle. When a trader trades with money that they can afford to loose they tend to be more focused and more disciplined. They are not worried about any single loss. Simply they are looking forward to the overall return. Don’t borrow money to trade on, don’t use your life savings and don’t use the money that you’d typically use to pay your monthly bills. This is just a road to disaster. Trading should be methodical; you should have a group of set principals that you follow each and every trade, by doing this you are working in a controlled environment, this will mean that you will have reproducible results.
Money Management Rule #7, always trade with money you can afford to loose.
The 7 Golden Rules of Money Management.
1. Never trade with out a stop loss..
2. Always trade with a Risk Reward Ratio of 1 to 2 or better on every trade.
3. Never over leverage your account.
4. Make realistic goals that can be achieved within reason.
5. Accept your losses, move onto the next trade, and trust your trading strategy..
6. Protect your profits when your position is profitable.
7. Always trade with risk capitol. .
THE ELEMENTS OF MONEY MANAGEMENT
PROPER EQUITY ALLOCATION
GOAL SETTING – Decide what your trading style and profit objectives are as well as your personal risk tolerance.
HOW MUCH MONEY SHOULD YOU RISK – The total amount that a trader puts at risk on any trade should be based on a percentage of your account balance or available equity. Over leveraging your equity balance can result in excessive losses rather than consistent gains.
DETERMINE YOUR RISK / REWARD RATIO – trading with a proper risk to reward ration is an extremely important part of trading. Determine what your risk tolerance is and aim for a higher profit objective. A 1 to 2 Risk / Reward ratio simply allows you to make 50% more per winning trade than what your possible loss expectation would be. By using strict Risk / Reward ratios, you will be able to direct more capital towards your trades with the highest probability of success.
STOP/EXIT TYPES
BREAK-EVEN – The break-even stop is very popular among traders and by far the most common. It ensures that you will only lose your spread (broker commission) if the market moves against you. It can be a detriment in the event the market moves against you for a small time and then goes the way you anticipated. You should give your trade enough room to allow the trade to develop.
TRAILING – The trailing stop is another popular method use to protect profits when a trade moves in the direction anticipated. You continually move your stop in the direction of your trade to protect your profit.
TRADITIONAL STOP LOSS – A stop that is set based on the equity balance and risk reward ratio of the traders account and/or style. Base on a certain amount of PIP’s or points as the maximum risk a trader will allow on any trade.
TIME STOP – A time stop is simply placing time limits on your trade for it to work out. The basic theory behind a Time Stop is that the longer your trade, statistically, you have a reduced likelihood that the trade will work out. The best trade usually work out immediately.
VOLITILITY - A volatility stop depends on recognizing that your risk level is increasing due to rapidly rising market volatility.
BARRIER – The barrier stop is taken when the market touches or penetrates some barrier, such as a point of support or resistance in the market.
Most beginning traders believe that a good entry into the market is the key to success. Unfortunately most are very wrong. Money Management is by far the most important criteria of trading, whether it’s stocks, futures or FOREX. Every successful trader will agree that managing your trades correctly is the #1 key to consistent profits.
Loosing a trade or several trades in a row is just part of trading, period! Having a plan and trading your plan is key to consistent successful results in trading, your trading strategy will help you recognize entry and exit points in the market; while most traders trade on the side of probabilities when entering into a position. Unfortunately, markets move in unpredictable ways at times and even the best traders are not always on the side of the move. In fact, many professional traders are right less then 50% of the time. Now, I can hear most of you saying to yourselves, “how can they make money if they are profitable less then 50% of the time”? It’s really very simple, Money Management! You see if you’re able to effectively manage your money you only need to be right about 50% of the time. The unfortunate thing about most of traders is that there primary focus tends to always be on making money and not protecting what they currently have. You see, you have a 50 / 50 chance of the market going your way by just flipping a coin. But let’s say you flip a coin and Heads you BUY and Tails you SELL. Once you have made your entry into the market you need to protect your position in the event your flip of the coin goes against you. Let’s assume for each $10,000 we use to control a position that we are only willing to loose $200.00 or 2%. Now we’ll also assume that for every trade you enter you expect to make at least twice what you’re willing to loose $400 or 4% and we’ll assume you have made a total of 10 trades, 5 winners and 5 losers.
Sample Trade log. (Hypothetical of course)
1. Buy USD / JPY ($200.00)
2. Sell GBP/USD ($200.00)
3. Buy USD/CHF +$400.00
4. Sell EUR/USD ($200.00)
5. Sell USD/JPY +400.00
6. Buy EUR/USD +400.00
7. Buy USD/CHF +400.00
8. Sell GBP/USD ($200.00)
9. Buy USD/JPY ($200.00)
10. Sell EUR/USD +$400.00
Net Profits $1,000.00
Can you start to see the importance of good money management in your trading plan? Sure you can, but most people have a real emotional tie to their money. It’s important to follow the rules associated with managing your trades for consistent profits. Setting a Stop Loss to protect your account is the first primary rule in trading (protect your profits.) Each time you enter into a trade have your Stop Loss point already set in your head and immediately set it on your trading screen.
Using a Stop Loss is only part of what your Money Management Strategy should be, but it is also a very important part. A Stop Loss is a form of insurance that you’ll be able to continue to trade by minimizing your losses in the event you’re wrong. It’s insurance for the trader.
Money management RULE #1 is to NEVER, EVER, EVER TRADE WITHOUT A STOP LOSS.
Now placing a stop loss is of course very important but placing a proper stop loss is very important too. By this I mean, always be aware of what your Risk Reward Ratio is and where your levels of support and resistance are. If you want to make $400.00 but are only willing to risk $200.00, then your risk reward ratio is 1 to 2. Let’s say you want to be even more conservative and trade only a ½ to 1 Risk Reward Ratio. Now on the example above you would have only netted $500.00 but you still netted $500.00! On a $10,000 account that is 5% of your balance. 10 trades in FOREX could simply be 1 trade per day Monday through Friday for 2 weeks. If you completed this for 4 weeks then you’re looking at 10% on your money in 4 week (or 1 month). Now I’ve been around for a long time and I’ve never seen a Bank pay me 10% on my money for 4 weeks! Now at a 1 to 2 Risk to Reward Ratio we would be looking at 20% in 1 month with out compounding.
Money Management Rule #2, always trade with a Risk Reward Ratio of 1 to 2 or better on every trade.
Leverage is another key to making money in the FOREX. No other market in the world that I know of allows the leverage that we see in the FOREX. 100 to 1 leverage is the normal fee that most Brokerages allow investors to trade with in a standard account.An example is this; for each $1,000 that you put up allows you to control $100,000 worth of currency! Think about that for a moment, it’s really incredible! That's like them lending you $99,000 dollars. This huge leverage is what allows us to make the kind of returns that the FOREX allows. But, it also enables us to loose some or all of our money if we trade foolishly. Leverage is a wonderful money making tool but when abused it can lead to financial destruction as well. Think about consumer credit cards for example. The bank lets you borrow large sums of money on your word that you’ll pay it back, but when credit is abused, it can lead to bankruptcy for many. So just like managing your credit debt you need to manage your trading leverage. Most people would not go out and rack up huge debt that they knew they could not pay because it would not be responsible, right. Well, when trading the FOREX if you started with a $10,000 account should you start by trading 10 lots? No, that would be foolish. A very conservative yet very effective method of trading is to never leverage more than 5% of your account on any 1 trade. With the example we used above, you could quickly grow your account to a very large amount in a relatively short amount of time. The compounding factor of money is a very powerful thing yet due to most peoples desire to get rich quick and take unnecessary risks, they tend to focus more on the dollar signs than on proper trading principles. If you truly want to make consistent profits and make exceptional returns on your hard earned money, take it from some one who’s been there, follow these simple but effective Money Management rules. A good rule of thumb is to keep your leverage at 5% or less. Your not able to make huge money, as the position sizes are only 1 10th of a standard account but the percentage of returns will quickly allow you to start trading larger sums of money and in the end will allow you the success you seek.
Money Management Rule #3, never over leverage your account.
Making realistic goals is another key factor to trading success. Don’t expect to make a living trading right from the start. There is a learning process that every trader goes through to become successful. Not only learning to enter and exit trades correctly, but also the process of controlling one's emotions. Many traders make ridiculous monetary goals when they first start trading. Make a simple goal to get consistent returns on your account each month. Have a plan and stick to it your plan; trade your strategy and the rewards will typically surprise you.
Money Management Rule #4, make realistic goals that can be achieved within reason.
Emotions and money do not mix. Simply treat each trade as a business transaction and don’t get emotionally attached to a trade. Take your losses and move on. Learning how to loose is probably more important than winning. Why, because a new trader will typically take their first loss and wonder what they did wrong, and then sit on the side-lines and let all the profitable trades go by. Discipline is another key factor in trading that tends to be a learned trait that takes a bit of time to get used too. So, accept your losses and move on. Trust your trading plan and trading strategy, as your analysis usually correct.
Money Management Rule #5, accept your losses, move onto the next trade.
Protecting your profits is another factor that helps insure consistent profits. If you’re a longer-term trader such as a Swing Trader or Position Trader, it is important to protect your profits by adjusting your stops to secure profits as you reach your profit targets in accordance with support or resistance levels. An example; lets say your taking a long position (Buying) the USD/JPY with resistance 100 PIPs away giving us a 100 PIP target with support 30 PIPs below our entry point this gives us a 1 to 3.3 risk to reward ratio if we are risking 2% of our 10,000 account balance or ($200) then we could place a trade with 6 lots (rounding down) this way our maxim draw down for this position will be just under our 2% risk tolerance. With our current risk to reward ration of 1 to 3.3 we are projecting to make just over 3% on our position or ($600.) during the course of our trade the market will follow the overall trend creating (higher highs) and smaller pullbacks or higher lows also known as the (imbedded trend.) As we follow our trade and make adjustments to our position we look to adjust our stops when price continues on the over all trend or breaks the higher high. We will adjust our stop just below the higher low or the (imbedded trend.) This now serves as a new level of support or (sub level of support) after price pulls back creating the higher low or imbedded this is now new support. This will minimize the risk to your account while still following the overall trend and adjusting our trade in accordance to technical levels of support or resistance. More advanced methods of Stop Loss Trailing can be covered with your continuing education.
Money Management Rule #6, protect your profits when your position is profitable.
Trading with money you cannot afford to loose is a very foolish thing to do, yet it is common among the beginning trader. When trading, be sure to trade only with money that will not affect your lifestyle. When a trader trades with money that they can afford to loose they tend to be more focused and more disciplined. They are not worried about any single loss. Simply they are looking forward to the overall return. Don’t borrow money to trade on, don’t use your life savings and don’t use the money that you’d typically use to pay your monthly bills. This is just a road to disaster. Trading should be methodical; you should have a group of set principals that you follow each and every trade, by doing this you are working in a controlled environment, this will mean that you will have reproducible results.
Money Management Rule #7, always trade with money you can afford to loose.
The 7 Golden Rules of Money Management.
1. Never trade with out a stop loss..
2. Always trade with a Risk Reward Ratio of 1 to 2 or better on every trade.
3. Never over leverage your account.
4. Make realistic goals that can be achieved within reason.
5. Accept your losses, move onto the next trade, and trust your trading strategy..
6. Protect your profits when your position is profitable.
7. Always trade with risk capitol. .
THE ELEMENTS OF MONEY MANAGEMENT
PROPER EQUITY ALLOCATION
GOAL SETTING – Decide what your trading style and profit objectives are as well as your personal risk tolerance.
HOW MUCH MONEY SHOULD YOU RISK – The total amount that a trader puts at risk on any trade should be based on a percentage of your account balance or available equity. Over leveraging your equity balance can result in excessive losses rather than consistent gains.
DETERMINE YOUR RISK / REWARD RATIO – trading with a proper risk to reward ration is an extremely important part of trading. Determine what your risk tolerance is and aim for a higher profit objective. A 1 to 2 Risk / Reward ratio simply allows you to make 50% more per winning trade than what your possible loss expectation would be. By using strict Risk / Reward ratios, you will be able to direct more capital towards your trades with the highest probability of success.
STOP/EXIT TYPES
BREAK-EVEN – The break-even stop is very popular among traders and by far the most common. It ensures that you will only lose your spread (broker commission) if the market moves against you. It can be a detriment in the event the market moves against you for a small time and then goes the way you anticipated. You should give your trade enough room to allow the trade to develop.
TRAILING – The trailing stop is another popular method use to protect profits when a trade moves in the direction anticipated. You continually move your stop in the direction of your trade to protect your profit.
TRADITIONAL STOP LOSS – A stop that is set based on the equity balance and risk reward ratio of the traders account and/or style. Base on a certain amount of PIP’s or points as the maximum risk a trader will allow on any trade.
TIME STOP – A time stop is simply placing time limits on your trade for it to work out. The basic theory behind a Time Stop is that the longer your trade, statistically, you have a reduced likelihood that the trade will work out. The best trade usually work out immediately.
VOLITILITY - A volatility stop depends on recognizing that your risk level is increasing due to rapidly rising market volatility.
BARRIER – The barrier stop is taken when the market touches or penetrates some barrier, such as a point of support or resistance in the market.
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