To be a successful trader, it is not enough to open an account and deposit it with some money. A rookie trader might not start earning immediately. Before anyone launches into trading on Forex, it would be wise to develop a smart program of money management.
Trading on Forex, control of a money flow in and out of a trader’s pocket is a “must know” to keep a trading account alive and make profits. It is a vital skill to keep an equal ratio between a profit amount and a loss amount per average trade.
Only in this case trading will be a gainful business, but not a game of chance and luck. Let’s consider the main principles of money management.
1. Every trader should have a reserve fund which is to be spent in case of emergency. An amount of a reserve fund should be at least half a deposit size.
2. To avoid losing all money, it is advisable to invest no more than 10-15%% of the whole deposit in one market.
3. A trade volume should not exceed 5%% of the total account equity. Otherwise, if a trader executes a losing trade, it is possible to face runaway losses.
4. Every trader is focused on big earnings. However, everyone should be aware of potential losses. If you invest your capital in a market of a certain type, the whole margin should not exceed 20-25%% of the cash flow as markets of the same type move in a similar way. In this case, it makes sense to optimize investments. To be exact investments should be diversified. If one trade turns out to be a failure, a profit on another trade can offset that losing trade.
5. A trader should determine to what extent one’s portfolio is diversified. Diversification of risks is one of the methods to hedge investments. A trader should always keep balance between concentration and diversification. If a trader opens several positions in parallel at least on 4-6 markets of different types, this strategy provides a quite safe allocation of one’s portfolio.
6. Stop orders Please make sure you set stop orders while you are getting away from your workplace in front of the trading platform. It will enable you to avoid losses. Besides, take profit orders are used to lock in profits in case a trading instrument moves in a favorable direction.
7. Profit/loss ratio In case a trend reversed in an adverse direction while a position is open, a trader should strike a balance between possible losses and profits. As a rule, the efficient profit/loss ratio is 3:1. Otherwise, it would be wise to avoid opening a trade.
8. Trading several positions Let’s assume a trader enters a market opening three positions. So it would be useful to divide them into position trade and trend trade. Position trader holds a position for the long term setting rather flexible stop orders, which enable this trader to keep a position even when prices go through consolidation and correction. Position trading is the polar opposite of day trading when a position is restricted by rigid stop orders. This strategy is used for speculations within the same trading day.
9. Rules of opening a position A position should be opened only in case an indicator generates at least one signal. Before a position is opened, it is essential to determine a market entry price, a price to close a gainful position, a price to close a losing position as well as time to hold a position open. A counter-trend position should be opened with caution for a short time frame. Similar things should be considered when trading on a sideway market.
10. Rules of holding a position and partial closing before a time frame expires A trader should hold a position open only if analysis confirms decisions made prior a market entry. It would be wise to close a position partially when current losses have already exceeded estimated losses or when a price has reached the level which is expected to gain a profit.
A trader should make a pause if total losses are still below estimated losses, a price is holding flat, or a price has not approached a level calculated to make a profit yet. 11. Rules of closing a position A time frame has expired. An estimated profit has been gained. A calculated loss has been reached. A position has yielded an utmost profit.
Please always bear in mind that a properly elaborated strategy of risk diversification is a steppingstone to gainful trading on the forex market.