Trillions of dollars are circulating in the Forex market every day. And if a trader wants to get his piece of this pie, he needs to have a profound knowledge of money management.
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Why control risks in the market
To succeed in the market, you need to learn how to grow your deposit while maintaining the balance between profit and loss. To achieve this balance, a trader needs to observe money and risk management rules. There is a popular expression among traders: “Cut your losses short, let your profits run.” Proper risk and money management will help you reduce your losses and grow your deposit. If you neglect these rules, even if you have a well-thought-out trading system, you won’t make a good profit, and what’s more important – you risk losing your entire deposit.
After all, it is so easy to lose control over your emotions when trading in the financial market, especially when you are in the red. And even if you trade at a profit, such emotions as greed can ruin everything too. Only the ability to take control over yourself and over your money can protect you from major losses.
True, any control implies a limitation of some sort. And by controlling your trades you limit not only risks but also your profits. However, only compliance with certain rules makes trading effective and profitable.
Risk management rules
Here are two simple rules to help you manage your capital.
- The 2% rule
- The 6% rule
To observe the first rule, a trader should set a limit for each trade – 2% of the size of the deposit. In other words, a trader can only trade this amount, as a more serious loss would jeopardize the entire trading account. To trade using the 2% rule, the amount of your initial deposit should be big, otherwise, it may be difficult to secure a profit. As your deposit increases, you should tighten this rule even further, gradually reducing your maximum risk in each transaction to 1% of the deposit amount.
Rule # 2 will protect a trader’s deposit from several losing trades in a row. If your account balance has decreased by 6% compared to the last day of the previous month, take a pause and do not trade until the end of the month. How often do you make this same mistake? You open trade and, when the market goes against you, you open a number of new trades, trying to win back your losses. Eventually, however, you find yourself losing a significant chunk of your deposit. Sounds familiar? The 6% rule will help you put your trading on hold, take a time out, and analyze which actions caused the unfavorable trade outcome.
In other words, the first rule protects you against one-time large losses, and the second rule encourages you to take the time to pause and make adjustments to your trading while there is still money left on your account balance.
A ready-made money management plan
There are various money management strategies, and the trader can choose the one that suits him best. You can apply only one strategy, or you can combine them – it’s up to you to decide.
- A trader divides his capital into two parts. The first half he uses in his trading and invests the rest of the money.
- If you trade by yourself, make sure that the profit to loss ratio is at least 1:1.5.
- The total volume of your transactions shouldn’t be higher than 15% of your deposit. Your risk per trade should be around 2%. Do not exceed these numbers.
- Diversify your risks. Trade various instruments, hedge open positions. It will allow you to maintain your profits even during unexpected and unfavorable market situations.
- Once a month, withdraw part of your profit and reinvest the other part of the money.
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