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Money Management

Money management is one of the most important aspects of forex trading.  Even the most brilliant traders aren't right anywhere close to a hundred percent of the time, and if you risk too much on a regular basis, it won't matter how good you are at technical trading or analysis of the fundamentals. 

Buying and selling the correct proportion of your total liquid capital is one of the most important aspects of money management, so, we'll start there.  It is, however, just one of several tactics that help to minimize your risk and exposure and thus set the stage for consistently positive returns.  So, this article won't stop there, but will explore each of the keys to successful money management for the forex trader. 

Let's look at the problem in the most simplistic of terms.  Let's say you invest 50% your capital in a single purchase, and because you leverage your money significantly – also generally a bad idea... always leverage cautiously –  you end up losing it all.  Now, you need to make a 100% return on your remaining capital just to break even.  But, invest 10% and lose it, and you've got to make a perfectly reasonable return of approximately 11%.  Invest 80% and lose it, though, you've got to make a 500% return with what you've got left.  90%, and you need to make an 1000% return.  See the exponential curve that's happening here?

The bottom line:  don't invest a large share of your money in any one investment.  If you do, eventually you will get unlucky, and lose enough capital that you'll lack the capacity to trade at the same volume you've been trading at... a recipe for failure. 

Stops are the other part of money management.  It's the Starsky to proportionate investment's Hutch.  There are four major types of stops. 

The equity stop is the most common of stops.  You simply place a sell order at a certain point, often 2% below your entry point.  That way, even though you are investing, say, $20,000, you are only risking 2%, or $400.  You can use equity stops both to get out when you've earned the amount you think you can get to in current market conditions and to get out early to avoid any large losses.  Adjust the percentage to fit your desired risk level.  Usually, 5% is considered the very height of riskiness. 

Volatility stops are another commonly used type of stop.  Basically, set parameters to sell when the market gets so volatile that it becomes too risky. 

Volatility stops are just one type of chart stop.  There are thousands of parameters you can use to create stops.  Chart stops are any type of stop that uses various technical indicators – and combinations thereof –  to decide when to buy or sell.

Lastly, there is the margin stop.  Unlike the other types of stops, this type is based more on your individual account and less on the market itself  If you are trading with leverage, you can place a margin call at any point of your account.  Let's say 90%.  That means, in effect, you get out of the market as soon the capital you've leveraged drops below 90% of its original value. 

If you combine these techniques – these four types of stops and investment levels proportionate to your overall capital – you can manage your money effectively in a way that let's you pursue significant profit but protects you from large losses.