Money management in a nutshell. Part 1

[Value trader]

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%.

Attachment 10666

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.

Attachment 10667

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…

[andry777]

It will be better if we will not use martingale trading strategy in forex, no matter how much proper money management you have one day it will come when we will not be able to recover our losses with this type of trading strategy. As you are saying that its a risky trading strategy because we are increasing our lot size each time when we are opening a new trade.

I think it's back to the trader himself, martiangle can be effective way to recover loss if you're expert in trading because expert trader is rarely facing losses more than 3 times in a row. But if you're not ready with the risk so it is true that martiangle shouldn't be done no matter how good your money management because in many conditions, traders can't stop trading although there is rule to stop trading after how many level which martiangle has been reached.

[lawners1791]

the martian gale strategy on appealing of risks level on distribution those to had with the basics on customs on decision to work of the multiply lotsize calculation on running with the order. as applying the higher expends on signals qualification or more on preparing the use with the margin on helping to sustain of the longer.

[shivanandfx]

I think it's back to the trader himself, martiangle can be effective way to recover loss if you're expert in trading because expert trader is rarely facing losses more than 3 times in a row. But if you're not ready with the risk so it is true that martiangle shouldn't be done no matter how good your money management because in many conditions, traders can't stop trading although there is rule to stop trading after how many level which martiangle has been reached.

For recovery of losses we should first correct where we gone wrong. Following money management is essential for Forex traders. I think better focus on few currency pairs.It is very good for a trader to be familiar with most pairs or commodities.However it is very helpful if a trader knows one particular pair or commodity very well.This way the trader can trade only that pair or commodity all the time and make good profits

[lawners1791]

those had with the basics on focus as trader manages of entries as having with the choice of system on referring the good accuracy on options as leaving chance with the decision on submitting risks with the better on confidence as haunting of good pips with the target on avoid the less on wastes by the decision as releasing funds with the work on complying with the business of the trading jobs.

[Hukam]

I think it's back to the trader himself, martiangle can be effective way to recover loss if you're expert in trading because expert trader is rarely facing losses more than 3 times in a row. But if you're not ready with the risk so it is true that martiangle shouldn't be done no matter how good your money management because in many conditions, traders can't stop trading although there is rule to stop trading after how many level which martiangle has been reached.

Mate I never get any update from a trader that he is making a very good consistent profit with martingale trading strategy, most of people are losing by it in this business, its not a good way to depend upon martingale. Its very hard to control this market if you are following martingale strategy. The random movement of market is not good for martingale so use stop loss in trading.

[hosny55]

many of us may ask about starting with a very small amount of money like those who want ot trade starting with 100 dollar . I think that the matter here is not money . the matter here is very related to te way in which we manage them and teh way in which we choose the trades lot size .

[forexfighter007]

Mate I never get any update from a trader that he is making a very good consistent profit with martingale trading strategy, most of people are losing by it in this business, its not a good way to depend upon martingale. Its very hard to control this market if you are following martingale strategy. The random movement of market is not good for martingale so use stop loss in trading.

In Forex trade we have to first look on safety. Risk management is risking what we can afford. It is a means to reduce our losses and keep our trading balance safe. Our losses are our own responsibility. Many traders open trade without any money management and without analysis. We should open a trade with utmost care and do our work before it.

[AmitChallenger]

In Forex trade we have to first look on safety. Risk management is risking what we can afford. It is a means to reduce our losses and keep our trading balance safe. Our losses are our own responsibility. Many traders open trade without any money management and without analysis. We should open a trade with utmost care and do our work before it.

Yes without learning to trade safety success is not possible here. Using money management in trading is the key thing in successful Forex trading. You should do learning first because if you try to trade forex without knoweldge , you will never get anything from here beside loss . So keep learning everyday to improve your knowledge.

[Sonia]

Forex business is a high risky business in the world. This business is worldwide. It is the largest market in the world. This market is larger than American stock exchange. Money management is the key to success in forex trading. If you can make a good money
management, your account will never fall in a problem.

[SuccessfulKartik]

Yes without learning to trade safety success is not possible here. Using money management in trading is the key thing in successful Forex trading. You should do learning first because if you try to trade forex without knoweldge , you will never get anything from here beside loss . So keep learning everyday to improve your knowledge.

Safety should be exercised here so that we do not lose a big amount in a jiffy. Money management is essential to lower our losses. In trading we should be using our skills and using our knowledge and experience. Most of the traders lose their money here. This market is like a treasure which have huge money but the journey of success here is extremely difficult.