Money Management

It is essential for anyone who wishes to begin trading on the forex market to learn how to manage money. If you trade without a system, just figuring you can afford losing x amount of dollars on a trade, it's a gamble, not a real trading strategy. Successful forex trading doesn't involve gambling and guessing at all. It involves research, analysis, and sound decisions for consistent profits.

Until you learn to wisely manage your money when making forex trades, you'll be as well off going to Las Vegas and spinning the roulette wheel.

Some people do get rich in casinos! you may argue. Of course, but far more gamblers lose their money instead. Only the casino owners turn a profit everyday. And those owners often entice a winning gambler to continue gambling by offering free hotel rooms, free dinner, free drinks. Then the gambler hangs around and still ends up losing all his money. Successful forex traders think like the owners, not like the gamblers.

Losing money is always easier than making it, no matter what endeavor you undertake. Forex trading is the same. Imagine that you lost half of your funds on a trade. You only have 50 percent left to try and get back to your starting place. What will happen if you lose another 50 percent? And another?

In a casino, you’ll hear a lot of talk about winning streaks and losing streaks. When a gambler believes he’s on a winning streak, he continues to bet it all on the next deal. You know what happens next. Suddenly, the deal goes against him, and he loses every last cent. Forex traders don’t go through winning streaks, but losing streaks are a constant, bona fide threat.

Imagine for a moment that 70 percent your trades return a profit. You can reasonably except to make money on seven out of every ten trades. By the same token, you will lose money on three out of every ten. This ratio holds true, however, only after you average the outcome of hundreds, maybe thousands, of trades. After 100 trades, you would likely have made 70 profitable ones and 30 unprofitable ones. When you’re first starting out, though, what if those first ten or 20 trades are all losers?

Successful investors trade using only a small percentage of their available funds. For instance, imagine that you have $10,000 available to begin your trading venture. What would happen if you have ten losing trades in a row? The numbers below show the result if you trade with ten percent of your finances (on the left) or five percent (on the right).

10 Percent 5 Percent
Bank Trade Bank Trade
$10,000 $1,000 $10,000 $500
$9,000 $900 $9,500 $475
$8,100 $810 $9,025 $451
$7,290 $729 $8,574 $429
$6,561 $656 $8,145 $407
$5,905 $591 $7,738 $387
$5,314 $531 $7,351 $368
$4,783 $478 $6,983 $349
$4,305 $430 $6,634 $332
$3,874 $387 $6,302 $315

By starting with $10,000 and using just ten percent for each trade, you would end up with $3,487 ($3,874 - $387 = $3,487) if all ten trades were a loss. If you traded five percent of your money each time, however, you would end up with $5,987 ($6,302 - $315 = $5,987). If you had used $1,000 on each trade, you would have had $0 after ten unprofitable trades.

Consider this: if your trading averages profitable trades half the time (50 percent) and unprofitable trades the other half of the time (50 percent), you can expect ten consecutive losses once out of every 1,024 trades. (Don’t forget that they could easily be your first ten trades!) On the other hand, if you average 70 percent profitable and 30 percent unprofitable, you would expect those ten consecutive losses to occur once out of every 169,350 trades.

The ten losses in a row is unlikely to occur during your first ten trades, but it’s more likely to happen than winning the lottery. This plainly reveals the necessity of building a system that will supply a significant percentage of lucrative trades.

You will more than likely be able to withstand ‘losing streaks’ by utilizing only five percent (or less) of your finances to make trades at any one time. As you make successful trades, your total bank account will increase, enabling you to trade with higher amounts--thus making higher profits--while still using only five percent of the total.

Special note: When you figure the amount with which to trade using an odd number (for example, five percent of $6,302 is $315), you should always round down. In this case, you could purchase one mini lot for $100 (with a one percent margin) and keep the other $200 in the bank in case the trade does not go in your favor.