Money Management in Forex Trading

[ntrader 10]

This thread is for those who like to discuss about the Money Management in Forex Trading . I am waiting for your thoughts in the most important ingredient to successful trading.

 

Risk reward is the most important aspect to managing your money in the markets.

Every trader in the market wants to maximize their rewards and minimize their risks. A risk-reward ratio of 1:2 means your profit target is twice your stop loss. If your trade has a Risk - Reward ratio of 1:3, it means that for every winner, you will need to lose an equivalent trade three times to lose all your profits. If you gain 900 pips in a trade (with a 300 pip stop loss) you would need to lose three trades using the same Risk-Reward ratio to cancel the profitable trade. This is why a forex trader can have two winners and three losers in a month and still make money.

[Colonel B 10]

Risk management = trade location. Risk management is NOT just placing a stop in or placing a profit target in that is larger then your stop out. Whatever your strategy is to getting into a trade it needs to get you in as close as you can get to the bottom or top of a move. If it is not doing that then placing a larger stop will not help you with managing your risk. Consider this concept. The slower you are in getting into the market the larger your stop out has to be. So the amount you can lose or the amount you are "risking" if you are wrong is larger.

 

I wouldn't need to risk more then 6-10 ticks on the 6E. The EUR/USD futures version. If you are risking 100 pips (I know alot of traders will tell you that is the standard) then I would say that is 16 times larger then you should have. You are using 100 when I am using 8. You might not but I am taking some liberties for the sake of a through description. Earlier entries gives you the chance to get out with profit before everyone else is getting in.

 

So the original topic is about money management. Money management cant be addressed with out a well defined understanding of risk management. The reason for this is this. It really doesn't matter what your profit to stop out is if you are buying at the top and selling at the bottom. You could put on any size stop out and it wont matter if you are buying at the top or are buying at bad prices.

 

But But But..... Nope doesn't matter. Buying at the top or close to the top will cause you to fail. You need to be buying at the bottom first and if you need a 300 pip stop out then that is not the bottom. It isn't even close or else you wouldn't need 300 pips or 100. If its 100+ then try to get it lower.

 

Now if you already have it lower then 100 or are working on it then good. On to the money management part. LOL

 

Scale. Yep that is it. Scale and then scale some more. Scale at what amount? Good question. I would scale at -.5 for every contract. So if you are trading 2 and you have a -50 pip stop loss then I would scale 1 of the 2 contracts at -25 pips. o.O? Wait what?? Yes figure out your risk first. Pro trader = Pro Risk Manager. If you get stopped out do you want to take a full stop out on all of your contracts? I don't and so I scale out. And I scale backwards as its going against me. Why mention this first? Why not just get to the making money part? Simple. Because that is the last thing you need to worry about. Trading is sometimes just as much about NOT losing money as it is making money. I don't care how much you are making if you are losing more. You need to limit your losers to be as less disastrous as possible.

 

I see all kinds of people talking about making money and how to make money and what stuff to use to make money. How about what to do to STOP losing money?

 

Now after all that how do I scale on the top end? YEA!!!!!! Well I get out +.55 and +1.1. So if you are using a -50 pip stop out with 2 contracts with the first coming off at -25. Anything over +25 would be a first exit. What you could do is as soon as it hits 25 move 1 of your stops to +24 and trail it. So that way it never is less then 25. Second is the same thing. Or you could just take them off at 25 and 50. The other option is if it hits your stop at -25 and then goes in your direction. Then take your second off at +26 for a scratch. Now if you want to be more aggressive then go for +50 for your first and +100 for your second but not much more then that.

 

Why so small? It has to do with something that no one talks about. And that is how to be a successful trader. What more do you need at this point? Noting really. You have a 2:1 risk to reward. You should be using a modest stop out and looking to buy at the bottom and selling at the top instead of the other way around. And that should be good enough. However everyone else is going for these big huge moves. Don't do that. Folks that do that are small traders and trade with small size. They have to have large stop out and large profit targets because they have small accounts. The secret is to bet more. You need to build your size. You get more money by going for bigger moves. You get more money by betting more contracts. Consider this. What is easier? To get 1000 pips with 1 contract? Or get 25 pips with 40 contracts? Its the same amount of money. Both are 1000 bucks but I think we can all agree that 25 pips is easier to obtain then 1000 or even 100 for that matter.

 

This is another novel but hopefully you and others will find at least something in it that is helpful to you and your trading. If not then print it out and use it in the bathroom and or the fireplace. Should be at least useful there. :rofl:

[BlueHorseshoe 10]

Careful now . . . Money Management (ie Position Sizing) and Risk Management are not the same thing.

 

BlueHorseshoe

[cjforex 10]

I think risk management, and position sizing are intertwined. Quite inextricably.

 

Here are my seven cents worth:

 

Trade small.

 

No, trade tiny.

 

Trade over many, many systems.

 

Manage your systems, dynamically distribute your money based on their performance (position sizing).

 

Try to find systems that are not correlated. Try the best you can. It's not easy. Distribute your funds based on their relative correlation. So not too many eggs in a correlated basket.

 

2:1, 3:1, 1:1 has no meaning beyond expectancy. Learn and understand expectancy, then expect it. When you don't get it, reduce the funds that system gets till you do get it.

 

Trade tiny.

 

Trade tiny.

 

Trade tiny.

 

Want to trade more money, find more systems.

 

Trade tiny.

[BlueHorseshoe 10]

I think risk management, and position sizing are intertwined. Quite inextricably.

 

Here are my seven cents worth:

 

Trade small.

 

No, trade tiny.

 

Trade over many, many systems.

 

Manage your systems, dynamically distribute your money based on their performance (position sizing).

 

Try to find systems that are not correlated. Try the best you can. It's not easy. Distribute your funds based on their relative correlation. So not too many eggs in a correlated basket.

 

2:1, 3:1, 1:1 has no meaning beyond expectancy. Learn and understand expectancy, then expect it. When you don't get it, reduce the funds that system gets till you do get it.

 

Trade tiny.

 

Trade tiny.

 

Trade tiny.

 

Want to trade more money, find more systems.

 

Trade tiny.

 

"Trade Tiny" - I agree with. Greedy people with short-term outlooks tend to over-leverage.

 

However, I don't agree that risk management and position sizing are intertwined.

 

Risk management (knowing where a stop-loss, a profit target, etc are placed) is part of developing a trading strategy.

 

Money management is all about getting the most out of that strategy (once you have it) through position sizing.

 

Think of it this way: risk management (entry, exit, stoploss, breakeven, trail, profit target, risk reward ratio etc) is like crafting a weighted dice; money management is all about knowing how often to roll the dice to maximise profits without the risk of going bust.

 

With poor money management you can go bust even though your risk management is impeccable. With great money management you can avoid going bust even though your risk management is terrible.

 

BlueHorseshoe

[Gekko78 10]

"Trade Tiny" - I agree with. Greedy people with short-term outlooks tend to over-leverage.

 

However, I don't agree that risk management and position sizing are intertwined.

 

Risk management (knowing where a stop-loss, a profit target, etc are placed) is part of developing a trading strategy.

 

Money management is all about getting the most out of that strategy (once you have it) through position sizing.

 

Think of it this way: risk management (entry, exit, stoploss, breakeven, trail, profit target, risk reward ratio etc) is like crafting a weighted dice; money management is all about knowing how often to roll the dice to maximise profits without the risk of going bust.

 

With poor money management you can go bust even though your risk management is impeccable. With great money management you can avoid going bust even though your risk management is terrible.

 

BlueHorseshoe

 

Blue ,

Yes I agree with you here. I really do not have hard "profit targets" I have a location where I would like the trade to go but how do we know that the market will hit it and not shoot right through it and continue higher/lower?? Yes we have trailing stops to help with that but those can also hurt you. When I was trading FX I used trailing stops all the time and the problem with them is that the market whips back all the time many times right to your original entry ....you get stopped out only to see the trade go back in your original direction 40-50 pips.....happens all the time. I like the "market" to tell me when to get out , not an automatic stop. I have lost out on much additional $$$ because of TS.

 

Trading small is key in the beginning in my opinion .......it allows you to access markets with a smaller amount of capital and have access to leverage. But , just because the leverage is there does not mean you have to use it. Your emotional state needs to be able to handle the leverage first before you can utilize it and this does not happen overnight.

 

The problem for new traders in FX is that they see they can make say $5 a pip on a 5 mini lot order and they think ......sweet all I need is a quick 20 pips and I made $100!!

 

The problem is as soon as they enter the trade they are already down $10 ( assuming 2 pip spread on EUR/USD) and they freak out .....as the lose $10 turns into 15, 20 , 30 in a matter of seconds...... This is hard for new people to handle .......so they get right out only to see the trade go their direction after they get out.........They do not understand emotionally how to handle it.

 

 

What helped me achieve success ( after losing my account ) was first finding my "F$ck it" number......that is the amount of money that I am comfortable losing mentally that does not affect me emotionally. So if I had a $1000 account , maybe that would $10 in the beginning....maybe $20......then as I build my account my "F$ck it" number increases as does my emotional stability.

 

I think success in trading is 90% emotional and 10% all the other things like RR , MM , entry , exits and such.

[cjforex 10]

BlueHorseshoe you are right. I misinterpreted. With respect to position sizing, you are absolutely correct. They are different issues. My apologies.

[fxdummie 10]

Before the risk to reward ratio, before betting any money, you need to have a system with an edge. System with backward and forward tests showing that over time in any market conditions the trading setups you are using will go toward the anticipated direction 50% more often and/or the winners will go farther then the losers.

 

Based on your personalty and life style you need to choose what edge to apply. You might not be able to stomach a long line of losers, so you have to find a set up which statistically will produce more winners then losers. You might be someone who like to win big. In this case you need to find a set up with winner bigger then the losers. I know professional traders who would suffer month after month recording small losses and make their money times 100 in a single trade or a single month. Their edge is not the amount of winners but their winning size over the size of the losers. I prefer a combination of both higher then 50% winning probability and higher then 1 win to lose ratio.

 

After you found a set up with an edge, and only after that you can think of position sizing, money management and trade management. Of course, part of the system testing would be placing stops and targets. But you need to test it for your self and experience real time the meaning of position sizing and trade management.

 

I would start risking the minimum - if I know the set up inside out and I can trade it while sleeping - then I can start risking more.

 

Trade management could be fully discretionary, semi-discretionary or mechanical. For super newbies I would suggest find a set up with an edge, risk the minimum, apply mechanical trade management rules and observe, observe and learn. After having being burnt many times and victorious even more you might start getting more experienced with your set up. You might start noticing that in certain market conditions your set up (system) needs larger stops or can achieve further targets. Then you can apply some discretion on stop and target placement, moving stops to break even, trailing stops, adding or scaling out. You might start applying a fully discretionary money and/or trade management when you breath the market - after you have become an integral part of his body...

 

Before you find a set up (system) with a proven edge it is a waist of time, effort and money to do anything else. And even after that the market never will be the same so, it is a constant leaning curve.

 

Most importantly, start smart, start small, be nimble, and don't lose money you can't afford! Forex is the best place to practice not losing money without betting too much of your account. And there is always a paper trading...

[SunTrader 10]

Risk is what you allow, reward is what the market allows.

 

1/1, 1/2, 1/3 are meaningless, price action and your reaction determines right hand side of the ratio. Which btw is almost always expressed backwards. After all it is risk/reward and not reward/risk.

[Colonel B 10]

Risk is what you allow, reward is what the market allows.

 

1/1, 1/2, 1/3 are meaningless, price action and your reaction determines right hand side of the ratio. Which btw is almost always expressed backwards. After all it is risk/reward and not reward/risk.

 

How do you double thumbs this? Totally agree

[ntrader 10]

One common mistake that traders often do is to over leverage their account. Today brokers offer leverage up to 1:500 for trading. Leverage is a two-edged sword it can work in the trader's favor or against him and usually leverage works against traders.

[fxdummie 10]

One common mistake that traders often do is to over leverage their account. Today brokers offer leverage up to 1:500 for trading. Leverage is a two-edged sword it can work in the trader's favor or against him and usually leverage works against traders.

 

ntrader, would you apply what you are saying ( I don't argue true or false) to the initial topic which is risk to reward ratio to be successful trader.

 

I see the leverage as a side trap adding to the initial pitfalls in which inexperienced traders burn their capital. On the other hand, leverage is instrumental in creating a wealth if you know what you are doing and are starting with very little money.

Edited February 11, 2013 by fxdummie
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[ntrader 10]

I believe that leverage is a two-edged sword, but especially for inexperienced traders most of the times work’s against them. The young traders tend to act as gamblers, doubling their exposure in order to turn the losing position around but most of the times are closing the position with huge losses. That is why money management is very important in forex trading, and you can make the right decision knowing the risk/reward ratio you only if you have long term experience, trading is a never ending learning process.

[fxdummie 10]

I agree, the newbie starts with what can be won using this indicator or that system. But money management has to become the "what-I-am-willing/prepared-to-lose" routine before one start using the "holly grail" indicator...

[ntrader 10]

Not using a stop loss or a profit take target is pure suicide. In Forex trading, an overnight event can send an unprotected trade badly into the negative territory writing huge losses. You can never know what will hit you especially these days with the currency war.

[tysonperry 10]

Money Management in Forex Trading is one of the most important things to take care of. Its mainly based on two terms risk and reward on your every trade. Until you understand actual trading money management techniques there is no chance to be a profitable trader. For getting more rewards you need to make a strategy to reduce your risks and to in increase rewards.

[ntrader 10]

Traders should be very carefull not to overtrade. Over trading can mean taking too many trades at a time, so increasing your risk exposure to the market. It can also mean trying to chase pips all over the market by placing too many trades in a day, especially after a losing run in an attempt to get back some of what was lost. Either way, you run the risk of losing big money and never recover.

[ntrader 10]

One basic rule that i try to follow always is to never risk more than 2% of my account funds on any one trade, which refers to the amount that may be lost, and not the amount that may be traded. You could trade 5%, 10%, even 20% of your account funds, but your stop-loss must not allow more than 2% of account funds to be at risk. Using this 2% risk factor and combining with the stop-loss range (number of pips), you can calculate the lot size that can be traded without exceeding your 2% risk factor if the stop-loss is triggered. The most important element in this calculation is the stop-loss.