You already know the fact that 90% traders lose money in Forex market, but you will be surprised by knowing that 71% of their trades are closed in profit (a dailyfx survey)! They literary give up all their profit and the account balance in 29% trades those went terribly wrong due to lack of forex money management.
I know your expression; you might be wondering- ‘How is that even possible?’
Actually, they close their trades as soon as they are in the profit but keep floating their losses. I’ve seen traders who closed 1 standard lot position in 20-30 dollars but took loss more than $500 from the same volume trade! Amateur Forex traders most often ignore the fact of money management or pay very little attention to it.
I already mentioned, in my early days I was in overall profit where I had only 35% winning ratio due to following the forex money management and staying disciplined. So you understand now, you can still make money even you are winning less! Let’s share a quote from legendary hedge fund manager Stanley Druckenmiller-
“I’ve learned many things from him [George Soros], but perhaps the most significant is that it’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” – Stanley Freeman Druckenmiller
The truth is you must have to follow a money management method if you want to take Forex as a profession and make money out of it consistently. The only question is ‘When are you going to start following it?’ I learned it with harsh experiences, like a child who learns not to touch fire only after being burned hands. A disciplined risk management will help you to improve your winning chances. Let’s discuss improving the money management skills.
Risk Minimization – How I improved my winning ratio to more than 90%!
Amateur forex traders always think about how much money they can make? And how to win? I was no exception. It’s all about winning, winning and winning. This is where they wrong! Winning big is a motto of gambling, not investment.
The illusion of winning will push you to trade more frequently but taking more entries not necessarily mean more profit actually, it’s the opposite, it increases the chance of losing. So, I stopped thinking about profit instead I focused on my wrong and losses. I was getting significantly better results by focusing on my wrongs. Professional traders focus on minimizing the risk not maximizing it. A better winning ratio is a byproduct of losing less.
Margin & Leverage – Destroyer of a trading account if you lose control!
Margin means you can have the access of much greater value of a currency, commodity or other assets than what you can actually buy with the money you have in your pocket. And leverage makes that to happen.
An example: You can have access to 100,000 worth of dollar (which is 1 standard lot) with $5000 in your account if you have 1:20 leverage!
Using leverage is only good when you know how to use them. Higher leverage always involves substantial risks; you should only be risking the amount that you can afford to loss (known as risk capital). Don’t consider investing from your student loan, mortgage or similar funds that necessary for your sustenance. Professional traders use as less leverage as possible in a trade. This is one of the top priority in their money management.
How much should I risk for each trade? Is it fixed amount or fixed pips?
I get asked this question almost every time when I talk about money management. But the answer is more complicated than that.
Actually, it depends on your trading style. A fixed percentage is not for everyone. There is a common metric is risking 2% is ideal for a trader! But if you are a day-trader and take many positions each day, then 2% is huge for you. 10 trades would make your risk 20% a day! That is huge! You will have to make more than 40% profit if you lose them in a row! I suggest 0.5% or even less for a scalper who trades in a lower time-frame.
The 2% risk with each entry is okay if you are a swing trader in the daily chart like me and take 3-5 entries a month; as you are taking 6-10% risk in a month. Sometimes, I take more than 5% risk with the Category A entries! I kept my monthly risk limited to 20% max and not more than 6-7% at the same time.
Every position you take has a different blueprint so, fixed pips SL make no sense hence every time the stop loss level is different. You have to follow the price action of the market; market not bound to follow yours.
Risk & Reward ratio: The difference maker and savior!
Risk & Reward ratio is the most important part of any money management method. I only take a risk while reward probability is at least double. Taking a risk is only logical when it’s worth it.
First 2.5 weeks of April (2017) was very dull for me and I did not take any significant entry. Mostly was few short range entries and risked average .5 to 1% max for each. But let’s show you how April becomes one of my top successful month with 2 massive risk and reward ratio entries, both on GBPJPY! I made more than 130% from them! My risk and reward ratio was 1:5 and then 1:16! I took only 6.20% risk each time! I increased risk due to the technical quality of the trade (It was a clean breakout).
I know another successful trader and coach Mr. Francis Hunt, who is the inventor of HVF theory. Most of his trade has massive risk and reward ratio, I’ve seen him often to take 1:20-1:30 R&R entries!
So, you can still make money even if you lose 90% of your trade! The primary step of a professional trader is applying risk and reward ratio filter to consider of an entry.
Using Stop Losses: You will give away your account if you fail to use it!
Stop Loss is only comparable with a double edged sword; it would cut you both ways! A narrow SL will be hit and wider than necessary SL will do significant damage. Putting stops in a safe distance is important.
There are few types of Stop losses traders use like fixed point/pip, Equity or margin stop, Chart Stop and Volatility Stop.
Does wider spread means more losses?
Not necessarily if you risk the same amount with each trade. Trading size is all that matters. Volume should get lower with wider stops. So, your risk and profit probability will remain same by adjusting the size of the trade.
We don’t suggest traders using fixed pips base stop losses, margin stops are better for institutional trades. Many scalpers/day traders use indicators like ‘bollinger bands’ ‘ATR’ for volatility stops. We focus on core price action and chart stops.
Forex market don’t care if you have 15 pips SL policy or 100 pips. Narrower stop losses increase the chance of being stopped out by the market noise.
Now you might ask Shaon ‘How do you put Stop Losses?’
Do you think ‘Warren Buffett’ or ‘George Soros’ call their broker to put SL just because the market move few pips against their trade? They do the opposite, they call them and tell them to take more positions!
You already know if you took my core price action course that I don’t use SL with every position. I categorize them into three types. Such as:
Category A: I don’t use SL for them. They are very rare (1 or 2 of them in a month is fantastic. They never faked in last 40 years! I take 5-10% risk with them (positions are held in 2-3 steps).
Category B: I use my hedging strategy for them. And I remain profitable even if the entry goes against my direction. Hitting this kind of hedging is lower than 10%! I take 2% risk with each them.
Category C: These are average quality entries. I take .5-1% risk with each of them (depends on quality and R&R ratio) and use SL. Their ratio for hitting stops is less than 30%.
First, I figure out the amount I am risking. E.g. 1% of a $10000 account is $100. And then identify the SL zone. I add extra 20-30 pips from the SL zone (mostly above/below swing highs or lows) so that SL can breathe. I always put SL above/below of any round number. Most market noise visits round numbers.
Cut the Losses short and let the profits run is not for everyone!
Stop being tempted by news agencies. Read from other traders who are successful not from a journalist who has never traded in his/her life.
There is nothing call cut the losses short and run the profit if you are a scalper, day trader or swing trader. You should close your position when reaches the goal. And you should wait and see the next price action from the target zone and ready to take a new position.
A trader who trades with a multi-month target can hold their profit for longer. But a day trader and swing trader should avoid such practice and focused on recent price action.
Currency Co-relation and double risking!
Make sure you are not trading co-related currencies When you are taking positions on multiple currency pairs. That increases your risk double. Ignore USDCHF if you are trading EURUSD, ignore NZDUSD and Gold if you are trading AUDUSD, ignore WTI/OIL if you are trading USDCAD. There are many other pairs, check the full list from the premium forum section.
Try to ignore major news events if you are not a news trader. News trading is not about guessing; it’s the combination of reading the economy and technical chart altogether.
Time Frame: Higher the timeframe, lower the chart noise.
As I mentioned, I only trade on Daily timeframe. The price action from a small time frame is very noisy. Higher the time frame you visit lower the noise you get. You will find a better Support & Resistant, trendlines for the daily chart in weekly time frame! Look at the daily chart to get a support & resistant for H4 analysis. This practice will help you to get a better view and edge on putting stop losses.
Trading Phycology: Be careful from your yourself!
Focus on minimizing your risk not maximizing the profit. Your first responsibility as a trader is securing your risk capital. Be defensive and you should always assume that you would be wrong. Now make your plan for how wrong you can be if the trade goes against your speculation?
Being wrong is not bad but keeping a wrong position alive is the reason your account would die. Stop praying and being emotional with a bad trade, they won’t help you. Emotions means, how you interact with the running positions. Like, if you remove the SL when market about to hit it etc.
Traders most often give away their winning to the next trade! So, don’t take an immature trade just because you had a win in the earlier trade.
Discipline and money management techniques will make you a successful trader. Only take a calculated risk that you can afford and don’t damage your trading account. Start with less, remember less is more!
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Thanks Shaon, Your article is very inspiring for a new trader.