Don’t you just want to learn one single thing that will dramatically change your trading for the better? I’m not here to tell you about the latest indicator or EA, but to go back to the basics and touch on a very important topic: money management. This is extremely overlooked by beginners and it makes a world of difference in deciding the winners and the losers in the market.
Your first money and risk management strategy
I’ve seen this too many times. You learn a few indicators, have some success and then start pouring money only to lose it all. And I’m not talking about irresponsible people, but smart, educated people starting out in the world of trading and jumping on the whole TA thing overlooking probably the most important aspect of your trading: how not to lose money.
The bottom line is that you’re going to lose some money in this business, no matter what, no matter how smart you are or how much experience you have. That’s why an experienced trader will always have a money and risk management strategy. As a wise trader once said:
“I’m a manager of bad trades, the profitable ones take care of themselves.”
A lot of people hear money management and just brush it off, like it’s some vague thing similar to: “don’t risk what you can’t afford to lose” or “don’t overleverage”. Don’t get me wrong, these are valid statements but money management is something much more and concrete.
Rule 1: Don’t get high on your own supply aka Don’t risk more than 1-2% of your entire balance on a single trade
This is a solid rule to start with. Some people realize that 1% of their deposit is very little in terms of dollars (or even 2%) so they’ll risk more just to feel better. Other people simply don’t understand measurements, like they think 10% is good enough to risk, opposed to what? Gambling on roulette?
There are also confusions, such as: “Yeah, I’m pretty sure investor X has 5% in gold and 5% in crypto, so if he’s willing to risk 5% that’s what I’m going to do as well“. This is so wrong, because portfolio management is apples and forex trading is oranges.
You should realize that by risking 5% of your entire trading account you only get 20 shots to stay in the game (a bit more because 5% will be calculated from the shrinking amount, but you get the point). And you don’t even need to lose 20 trades, after 10 losing trades you’ll easily go on a tilt because half of your trading account will be gone.
With 2% risk per trade, you get 50 shots before you can get wiped out, and that’s a big increase. But when you are a beginner I recommend you go with just 1% risk, which is a super generous ammo belt giving you 100 power shots.
“But it doesn’t happen like this, nobody loses 10-20 trades in a row.” – you’d think a few green trades between the red ones are going to save you, but think again, it’s just delaying the inevitable, your trading account will slowly bleed. Which is worse, because you might not even notice it. It would be great if you could lose it fast so you can adjust and do better, rather than slowly bleed and keep adding more money hoping your system will pay off later.
Rule 2: Set a profitable Risk/Reward Ratio (RR)
Your 1% risk per trade won’t be enough if your trading system has more losses than wins and your profits are too small to cover the losses. For example, let’s say you have $1000 in your trading account and your stop loss is set at $10. When you reach $10 profit, you might be tempted to take it and bank an extra 1%. If you’re willing to lose $10 and profit $10 then your risk reward (RR) ratio is 1.
But what if you have the same amount of losses and wins? Then you’ll break even (actually a loss if you count commissions, slippage, swaps) because for each $10 you gain, you lose another $10. In this case if you want to be profitable you need to take more profit. Let’s say $20 instead of $10. This will give you a 2R system, which means your reward is twice as much as your loss.
In practice you need to test and back-test your system to find out what’s your winning rate and what’s the sweet spot for the best RR. This is the first time I discovered how to see if a system is profitable or not. Because you might get some winning trades in the beginning but overall the edge could be negative. Check out these beginner friendly trading systems which usually have a positive edge as they’ve been tested many times.
Staying in the market is more important than anything, because if your account gets wiped out you can’t play the “forex game” anymore. Even if you went all in with huge risk and over-leverage and won, that’s not something you can rely on because it’s gambling. You should aim at minimizing losses to allow yourself to have more chances at becoming better and eventually build your own system that makes money consistently.