Money Management – The Holy Grail Of Trading
Money management determines how much to risk on each individual trade. This is a vital element of any trading system – risk too much and the chances of going bust are too high, risk too little and the reward for trading is too low.
The main methods for calculating trade size are:
The number of contracts to trade is determined by a fixed percentage of current equity. As only whole futures contracts can be trade this, effectively, means that the trader uses 1 contract per $x of equity. For example 1 contract per $10,000.
Fixed fractional, however, requires unequal achievement at different contract levels. For 1 contract every $10,000 to move from 1 contract to 2 requires a profit of $10,000 from 1 contract. To move from 10 contracts to 11 still requires $10,000 profit but from 10 contracts. So for smaller account sizes it will take a long time for the money management to actually kick in and for larger account sizes the number of contracts traded will jump wildly around.
Using fixed fractional the number of contracts traded would be calculated as equity/x, where x=dollars per contract ($10,000 in the above example).
Contracts – Equity Required $
1 – 10,000
2 – 20,000
3 – 30,000
4 – 40,000
5 – 50,000
6 – 60,000
Fixed ratio adds a variable to the fixed fractional method.
Fixed ratio adds delta to the calculation. The delta is a factor which is required to move to the next contract level. The lower the delta the more aggressive the money management is.
The formula is:
equity required to trade previous contract size + (number of contracts x delta) = Next level.
Eg starting with a base of $10,000 for 1 contract and a delta of $5,000:
Contracts – Equity Required $
1 – 10,000
2 – 15,000
3 – 25,000
4 – 40,000
5 – 60,000
6 – 85,000
Comparing the above table to that for fixed fractional it can be seen that at the lower account levels less equity is required whereas as the account grows the number of contracts traded becomes less aggressive.
Tim Wreford runs Online Futures Trading, a website that provides information and resources for traders. Tim also provides a free day trading system, the results of which are updated daily on the site.
It’s a sad fact that 90% of beginner Forex traders blow up their trading accounts in their first month of trading. The surprising thing is, this happens regardless of whether they have a profitable Forex trading system or not! Clearly, there’s more to making money in Forex trading than having a profitable Forex trading system. What most beginner Forex traders don’t realize is that when you’re just getting started in Forex, having a good Forex money management strategy is far more important than having a system with huge returns. By the end of this article, you’ll know how to apply the best Forex money management strategies for consistent, safe returns from your system.
The Best Forex Money Management Strategy
Even if you have the worst Forex trading system in the world, you won’t blow up your trading account if you have a good Forex money management strategy. On the other hand, without a good Forex money management strategy, you could have the best Forex trading system in the world and it wouldn’t even matter. That’s how important money management in Forex is!
Before we get into the nuts and bolts of money management in Forex, you need to understand how important it is to protect your capital when you’re trading Forex. Unfortunately, most beginner Forex traders start out with too little capital. They try to turn $1,000 into $100,000 by being extremely aggressive and risking a big chunk of their capital on their trades, and when the inevitable loser comes along their account take a huge hit. It’s like taking two steps forward and three steps backwards every couple of days: frustrating and unsustainable in the long term.
Believe it or not, the best Forex money management strategy is to dial your risk per trade way down to between 2-4% of your capital. This is the best cutting edge Forex money management strategy that all the big banks and hedge funds apply for all their traders, and I highly recommend that you apply it as well. It’s called the % Capital Strategy, and it provides the optimum growth of your trading account with almost zero risk of blowing up your trading account entirely.
An Example Of Good Money Management In Forex
Here’s how it works. If you’re really conservative, go with 2%, and if you’re really aggressive, go with 4%. Any higher or lower and you’re literally throwing money away. For an account size of $10,000, using a conservative setting of 2%, your maximum risk per trade would be $200. That means that if you have a stop 20 pips away from your entry, then you’re allowed to take a maximum of 1 full contract.
A key decision that you need to make early on is whether you want to re-invest your profits or not. Obviously, re-investing your profits will allow you to leverage the power of compounding returns, while withdrawing your profits will not. By re-investing your profits, you can literally double or even triple your profits in a year! If you decide to re-invest your profits, then you’ll have to update your risk per trade allocation and your position sizes at regular intervals. I would recommend updating your position sizes every 5-10 trades, so that you’re getting the best compound growth of your trading account.
It’s important to remember that you’re still going to need a proven, profitable Forex trading system to make a consistent Forex income. Even the best Forex money management strategy will not make a bad trading system profitable, but without a good Forex money management strategy it’s impossible to make a lasting Forex income. Be sure to have both of these two essential Forex trading elements in place, and you can be sure of your Forex trading success!
I’ve been a full time Professional Forex Systems Developer since 2007. Forex trading is my passion, which is why I really love helping anyone to overcome their challenges and become profitable in their own Forex trading. If you’re just getting started in trading Forex, or if you’d like to take your trading to the next level, I’d love to help!
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