Money Management

We have been asked several times, no, we have been asked a hundred times – what are the secrets to trading the Forex Market successfully? And we have always answered the same: if there is a secret to trading the Forex Market successfully, it must be to have equilibrium between —

— Having a good system, a money management plan, good trade and risk management and to be psychology tuned.

Each one of them is equally important and every trader should spend some time studying each one of them.

This is an important point for all prospective traders to understand– the point at which they realize searching for a secret way or the Holy Grail is wasteful and pointless. We all started off thinking there must be one hidden thing all successful traders know or an elusive key to the markets and as soon as I get to know that I will succeed. Sorry, but they all succeeded from hard work and a balance of the 4 things above. As soon as you stop looking for the non existing “secret” you will stop wasting time and use that time and effort to become profitable

You cannot drive a car with a flat tire, or maybe you can, but you won’t get too far – and probably end up going in circles. The same goes for trading, you won’t get too far if you don’t devote the required effort to each aspect.

We will go through each important aspect of trading throughout the course. Let us now turn the talk to money management.

You have probably heard of traders making huge killings in the market on those trading contests organized by brokers. What kind of money management are the majority of those traders using? None.

To make, say, 200% a month a trader should elevate his or her risk to a similar percentage in order to be able to achieve those results. These kinds of risks will only lead us to eventually to wipe out our trading accounts. You cannot rely on that kind of methodology when you have to pay the bills because the risk of ruin is too high.

What the contests organizers do not tell you is the number of traders that blew out their trading accounts on those contests. The number of traders can go as high as thousands (producing a bunch of profits for the organizer brokers). They just tell you about the “incredible” results a few lucky traders achieved during a profit windfall (lucky because you will never see the same trader twice at the podium).

When we trade like this is just a matter of time before huge losses occur, outperform the winnings and finally the trading account vanishes. At this point, the trader is devastated, both financially and emotionally. And believe me, getting back and recovering is a hard thing to do. (Although we have had a number of students come to us at this point so can say with confidence that it is not the end of the world and often they come back better and stronger).

Luckily, this is exactly the main purpose of Money Management (MM): to avoid the risk of ruin. By having a money management plan you are making sure you are going to be able to trade tomorrow, the next week, months and years to come.

MM should not be confused with trade and risk management (i.e. trailing stops, where stops and target should be placed, adding to a position, etc.) MM answers only one question: How big my position (trade size) should be in my next trade. Moreover, it is the same question we are going to answer in this lesson.

This lesson is structured in the following way:

Section 2: Everything about MM

in this section we will review all the basics of money management.

Section 3: Martingale and Anti-Martingale

all MM techniques follow one of these two approaches; we will review which approach is best one to trade the Forex market.

Section 4: One Contract for Every $XXXX

this is the easiest and most common MM technique applied.

Section 5: Fixed Fraction

a technique that increases its position size when the account increases its value and decreases its position size when the account decreases its value

Section 6: Optimal f and Secure f

MM techniques developed by Ralph Vince that states that there is always an optimal trading size

Section 7: Fixed Ratio

MM technique that takes advantage of the geometrical growth of the trading account.

Section 8: Two Important Things to be Considered

these two concepts play an important role in MM

Section 9: Summary

A brief summary of the chapter