Regardless of how good your trading strategy is that you have learnt in your Forex trading course, how smart you are or how intelligent your algorithm is, it all means nothing without money management. Rather than writing about how you must use stop losses, only risk a set % of your account or “never risk more than you want to lose” we are going to look at just two slightly different styles or money management and their pros and cons.
Style 1 – Changing your position size to risk a fixed percentage of your account per trade
This is the ‘straight out of the box’ money management taught at every credible Forex trading course. New traders will assign x% of their capital for every trade and then change their position size to suit the distance to their stop loss. So, if their trade turns out to be a loser, they know that they are only going to lose that set % of their account. Whether it is 1, 2, 3, 6, 10 or 50% of their account, the decision is theirs (the varying amounts you can use are not going to be discussed in this article). This is a great way for a new trader to approach trading as it will really help to limit their losses and preserve their account balance for as long as possible until they reach consistency.
But, there is one major problem with fixed % of capital trading that will severely hamper a consistent trader. If you risk 2% on every trade and have 10 losing trades in a row, you have lost 20% of your account. This means that is now going to take more than 10 winning trades in a row to get you back to where you were initially, as your 2% value is lower. So, once you have experience and consistency with your strategy it is very inefficient to trade this money management style. However, once you learn Forex trading strategies that are frequently successful it may be time to re-consider this approach.
Style 2 – Fixed position size trading
Usually, when people start to learn Forex trading, they try and trade this style too quickly, before they really understand and have the knowledge of the statistics of their strategy – this usually results in a quick blow-up of their account. With fixed position size trading the trader will decide that for every single trade he puts on he will risk a set value per pip whether it is 1 GBP, 5 GBP or 1,000 GBP (the varying amounts you can use aren’t going to be discussed in this article. In order to trade in this style the trader must have a solid grasp of his/her trading strategy, have thorough logs and know precisely what his/her largest losses/biggest draw downs have occurred over time. Enough data is required to know confidently that worst losses have been identified and solved. Once this data is sufficient a pip value can be assigned to the trading strategy and really make the most out of the trades that “go like a flier” and make lots of pips. This is certainly more favorable to being stuck on a lower position size.
Working towards ‘Style 2’ takes many months and experience, not so much with your trading, but with your statistics. Your statistics must be solid; there must be no incorrect entries or losses due to breaking rules, or exiting early. Your statistics must be an accurate and a complete representation of your trading strategies and how you trade. A thorough and complete Forex trading course will teach you how to work towards this and attain making the larger profits from fixed position size trading. Changing your position size to maintain a fixed % of your account as risk will protect your account, but not grow it efficiently.
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