Money management in a nutshell. Part 1
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    Money management in a nutshell. Part 1

    Hi traders. I’ve looked over the forum and haven’t found any decent thread about money management and this topic is not just important. Proper money management distinguishes survival from failure.
    I see too many traders with enough experience who continue blowing up their accounts over and over again just because they fail to manage their capital properly, they take too much risks for their positions.

    Why is this important?

    You may ask – if my trading system is good and I can generate good entries on consistent basis, why I should care much about this? I can take high leverage and earn money, that’s how it works, isn’t it?
    No. Our ability to predict market moves or even be right more than 50% of the time is limited naturally. By accepting this fact you recognize that in your trading you WILL have drawdowns. You will have losing days, weeks and months (I hope, not years, but it is also realistic). And you have to be prepared. Of course, you will do everything to reduce your drawdowns, to adapt your strategy or trading plan to changed market conditions, but drawdowns are the part of the game – one can’t sustain permanent growth without corrections.
    Once you accept the fact that your abilities to predict market action (as well as any other person’s abilities) are limited, you come to importance of money management. You need to survive.

    Mathematics of survival.

    Let’s assume that we use very simple money management principle – in each trade we risk certain amount of capital, say – 2, 3 or 5%. If you had, say, 1000 USD at the beginning of this process and put 5% at risk, you will have 950 USD if you are stopped out of your position. After that, you will be able to risk only 950*5% = 47,5 USD and so on.

    In a graph shown below you see quantity of losses that you can possibly have before losing entire capital. Of course, it’s just theoretical graph – it doesn’t take into consideration lowest possible trading size, margin, spreads and commissions. But it shows that when your raise your lot size, you decrease robustness of your trading in non-linear way. Having 6% of capital at risk is more than 2 times riskier that having 3%. Having 10% at risk is more than 2 times riskier than 5%.

    capital.png

    To survive possible tough times, your trading needs to have enough level of robustness. Even if you flip a coin, you will have greater chances of survival if you apply appropriate money management rules. But if you analyze the market and achieve good profit/loss ratio, you would expect not only to survive but also to have your equity curve going forward.

    Martingale:

    The easiest way to blow up your account is applying martingale principle. You increase your lot size twice after being stopped from the position. In this case you have basic assumption that market will inevitably return at least to a point where you opened your first position. You average your loss expecting to cover it if price returns. In most cases it works, it may even work for some long period of time, but in case of directional break, your losses will inevitably exceed your available margin – thus, your account will be liquidated. «Not for me, not this time» - this is a prayer of every martingale trader.

    martingale.png

    Fixed proportion method:

    That’s the simpliest money management principle. You just take 2-3% of your capital (or whatever) and calculate it from your available margin (deposit size). When size of your deposit decreases, you also reduce your size, when it increases, you slowly increase your size.
    Every money management principle has it’s benefits and drawbacks

    Benefits:

    Robustness, ability not to lose much in case you experience unexpected drawdown

    Drawbacks:

    Slower recovery. If you would risk fixed fraction in your trade (say, fixed amount in dollars), you would recover more quickly in case of drawdown. But of course, in this case you would accept greater risks

    Fixed fraction method:

    In this case you simply put predefined amount in dollars at risk in each trade. If you start with 2000 USD and decide to put 100 USD at risk in each trade, you are not expected to change this trade size even if your equity goes down. But you should increase your lot size as your equity curve goes up.
    This money management principle is the most aggressive and definitely not recommended for beginner traders.
    Your leverage will increase as (if) your equity goes down and your risks too.

    Benefits:

    Quicker recovery from drawdowns

    Drawbacks:

    Relative loss size (and risk) increases as equity goes down

    To be continued…

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    Rookie rinaji's Avatar
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    Thanks for this useful thread, I've been using all the methods that you mentioned. Martingale, Fixed proportion method, and fixed-fraction method.
    But honestly, I've been traumatized by Martingale, 1 year I use martingale method, I always get sad condition at the end of the story. That's the reality that I have experienced. I did some experiments with variations of a martingale, including: averaging martingale, hedge martingale, pyramid martingale, martingale + stop loss (single position) based on signals, etc.. All I've ever done.

    Now I only use the last two methods in some of my accounts, fixed proportion method, and fixed-fraction method.

    One more note, I still find a lot of traders that determine risk for each trade, but does not run properly, either do not understand or somehow. For example: we set 10% risk per trade, but allow floating minus position more than 10%. So the maximum drawdown is more than 10% of the equity, I think it is not right.

    I am waiting for an update from this thread, interesting to learn more, I am still trying to learn, learn, and learn again.

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    Money management is one of the greatest part of this business. When trader are trading on this business that time trader of some are getting loss and some are getting profit. Basically most of the loser traders fall in loss by the lacking of money management. When we are having this type of money management then we are able to making money also.

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    Registered user usd100000's Avatar
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    Quote Originally Posted by Value trader View Post
    Martingale:

    The easiest way to blow up your account is applying martingale principle. You increase your lot size twice after being stopped from the position. In this case you have basic assumption that market will inevitably return at least to a point where you opened your first position. You average your loss expecting to cover it if price returns. In most cases it works, it may even work for some long period of time, but in case of directional break, your losses will inevitably exceed your available margin – thus, your account will be liquidated. «Not for me, not this time» - this is a prayer of every martingale trader.
    I think who like martingle they can see the history of gbpjay. In 2013 the price was less then 150. and now it above 170 level. So think about them who sell at 150 ,151........160,161,162,163.....170. How many position they opened? I think they all blown up their account.

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    This is a nice educator through which came to learn about money management in details. I become very enriched by reading this educator and I copied it in my learning tools so that I can study it further. I am very weak in money management and cannot able to learn better knowledge about this. This thread will help me to achieve it.

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    Rookie rinaji's Avatar
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    Quote Originally Posted by usd100000 View Post
    I think who like martingle they can see the history of gbpjay. In 2013 the price was less then 150. and now it above 170 level. So think about them who sell at 150 ,151........160,161,162,163.....170. How many position they opened? I think they all blown up their account.
    Depending on where they put the next level for the martingale, does not always have to put on 150 for the first level, 151 for the second level, 152, 153, 154, and so on. That means they put a martingale level with a range of 100 pips/ level. What if there are traders who placed 200 pips / level? or 300 pips per level? Each trader has a different way. But I have a suggestion for traders who use a martingale, we recommend putting the level of a martingale is based of signal. If you do not get a new signal, then you do not put the next level.

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    Forex is a very lucrative market and it is not very easy to follow the 2 % risking rules here. Many traders do not show interest in learning before trading and trading without money management, these are making the majority of losses in Forex.Money and risk management is crucial in Forex trading. Most of the newbies fails just because of not doing proper money management. It helps to reduce loss. Its helps us to become successful by reducing our losses and then increase our profits.

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    Rookie mohabbat's Avatar
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    Quote Originally Posted by subhan04 View Post
    If you don't have money management skills then it means that you can never become a good trader. I am learned this thing in last 5 years and now quite happy with the results. Money management requires lot of patience and brain in order to become effective in this particular area because most of the traders lose their money because they have not learned this skills from seniors.
    Yes dear, you are absolutely right. because without proper money management rules any body never become from their loses and it is profs. because after maximum investigation we got this massage from maximum loser. so we should to be careful about our money management rules which always helpful for fund saving from big loses.

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    Don't loss you hope.

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    the mathematics of survival shows the way of as extents with the plan on running those with the schedules with the rules on having the good terms with the risks and the target to complete. that more of those good trader should prepare also the good value of the system on running with the work to deliver the stable on sustains on managing the request and to avoid of the worse with the chance of not to losing the good games.

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    Quote Originally Posted by Touhid View Post
    Money management is one of the greatest part of this business. When trader are trading on this business that time trader of some are getting loss and some are getting profit. Basically most of the loser traders fall in loss by the lacking of money management. When we are having this type of money management then we are able to making money also.
    I am also agree with you that money management is very important part of this business. With the help of this components people are easily lead their business, otherwise people are also loser here. Proper working plan and good money management when combined with each other then people must be earning profit from this business more and more.

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