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Money Management

Money management is a risk management method that allows you to maximise your odds of succeeding. Its rules are based on the adjustment of the size of your positions and your management of stops; you’ll have to follow these rules with no exceptions. Every trader should know this technique since it allows you to 1) benefit from your analysis errors, 2) preserve your capital and 3) significantly improve your probability of making money. Mastering risk is essential in order to achieve success.

 

Exposure to risk

You have to determine a percentage of maximum loss you’re willing to lose on each trade. In general, exposure to risk for each trade should represent between 1 – 3% of your capital.

10 losing trades with 1% risk = 9.55% lost
A 10.55% profit will be needed to get back to your original balance.

10 losing trades with 3% risk = 26.33% lost
A 35.75% profit will be needed to get back to your original balance.

 

Position sizes and stop losses

You will have to adjust the size of your positions and stop-losses according to the maximum percentage of loss that you’re willing to accept on each trade.

For example, if your strategy features a 50-pip stop loss (don’t forget to take into account the pair’s volatility) for a 10,000$ account, and you decide to take a 1% risk, your maximum loss would be 100$ and the position size would be 20,000 (2 dollars per pip).

If you open a second position on the same or with another currency pair with a strong correlation coefficient (such as EUR/USD and GBP/USD – see the correlation table), the lot size will be 10,000 each (1 euro per pip) and the risk will therefore be .5% per position.

If you open a second position on another pair (with low correlation with the first position opened), the 1% risk shouldn’t be calculated on the original 10,000$, but on this amount minus the amount used for the first position.

 

Example with a $10,000 account, leverage = 10

The first position of 20,000 (stop loss at -50 pips, 100$ maximum loss) uses 2,000$ of your capital due to your use of leverage. The remaining margin left in your account is 8,000$.

For the second position, the risk is again 1%, but is calculated from 8,000$ (80$ maximum loss). The position would need to be of 16,000 (1 pip = 1.6$) and the stop loss at -50 pips. If your broker requires a specific lot size, you can just take another position of 20,000 and reduce the stop-loss to -40 pips.

 

Trade entry

The biggest gains are made off of trends. A trader who is able to follow a trend will maximise his ability to profit. His primary objective is therefore to “work” on these trends.

Trends don’t last forever. It is therefore crucial that you don’t take a position too late in the game, and you should watch out for potential reversals by using technical and fundamental analysis.

 

Monitoring your trade

Once you have a position open, your objective is to both maximise and protect your gains and limit your losses.

If the market is in the middle of a trend, and you’re on top of things, the best way to maximise your gains is to use the pyramid strategy, which consists in reinforcing your positions.

In order to protect your gains, you have to make your protective stops evolve when the prices evolve in the expected direction. If the stops that you’ve placed are positive, you can choose to widen them in order to follow the trend as long as possible.

In order to limit your losses, you must closely follow the plan you’ve established. If the market isn’t going in the right direction, don’t reinforce your positions and don’t modify your protective stops.

 

Trade exit

An exit can be made because of a stop or because you’ve achieved your objective.

If you’re trying to jump onto a trend, it is recommended that you not have an objective. Your exit will be the result of a stop, in order to eliminate the psychological factor and not miss out on a big trend.

An exit based on an objective can be achieved using a risk/reward ratio. For example with a 2:1 ratio (profit taking at +60 pips and a stop-loss at -30 pips).

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