Money management is usually the most important “X factor†that determines the overall profit or loss of forex trading strategies. This is so frequently overlooked that it needs to be said over and over again. It is one of the key trading essentials. Money management in itself won’t give you a winning edge – you need good trade entry and exit strategies for that – but without intelligent money management practices, a winning edge will not see its full profit potential, and even risks producing a loss overall.
There are two elements to money management that traders need to consider carefully: how much of your account to risk per trade, and how much of your account should ever be at risk whether measured in total or by some kind of sector. There are not necessarily “right†or “wrong†answers: what is best for you will depend to a large extent upon your own appetite for risk and tolerance for loss, whether temporary or permanent.
Account Risk
Whenever you open a trade, you are risking money. Even if you have a stop loss, you might suffer negative slippage and lose more than you accounted for. Obviously, if you have a large number of trades open at the same time, even if they all make sense at the individual level, they might together constitute an unacceptable level of risk. Likewise, if you have a lot of trades open that are all betting on the same currency in the same direction, you run a risk of a sudden loss beyond what is acceptable.
For these reasons it is a good idea:
– To determine a maximum size of open trades that you will have at any one time; and
– To repeat the above but per currency.
For example, you might determine that you will never have more than 2% of your account size at risk in open trades, or 1.5% at risk on a single currency. You should also be extremely careful when trading in currencies that are pegged or capped against another currency by their respective central banks. For example anyone who was short the Swiss Franc last January using even a relatively very small true leverage of 4:1 would probably have had their account wiped out, regardless of any stop loss, as the slippage was so great.
