Forex Money Management 2
2. Calculate risk/reward ratio before you enter a trade
When the chances to win in a trade are smaller than potential losses, do not trade! Remember staying aside is a position.
For example:
losing 50 pips versus winning 40 pips,
losing 30 pips versus winning 30 pips,
both examples are showing a bad risk management.
Before entering a trade, reassure that risk/reward ratio is at least 1:2 (but ideally 1:3 or higher), which means that chances to lose are tree times less than promises to win. For example: 30 pips of a possible loss versus 100 pips of a potential win is a good trade to consider taking.
Adopting this money management rule as a must, in the long run it will dramatically increase your chances to succeed in making stable profits.
3. Learn to use protective stops
Every day hundreds of Forex traders blame themselves for being so naive and trading without protective stops. Hundreds of others lose funds worth weeks, months & even years of trading just only in one very unsuccessful trade.
And yet another hundreds of traders, having heard dozens of times about importance of protective stops, open new trades ignoring the well known money management rules.
Stop loss is not often a favorite tool for many Forex traders as it requires taking necessary losses, calculate risks and foresee price reversals. However, a Stop loss tool in hands of a knowledgeable trader becomes rather a powerful trading weapon than a cause of disappointment and painful losses.
Every trader is free to develop his/her own trading style and implement own money management rules. We will go over several methods of using Stop losses.
Simple equity stop
It is an important money management rule not to risk more than 2-3% of your total account per trade. According to this rule, a trader would place an order and based on a lot size would calculate amount of pips required to reach the limit of 2-3% of the total account balance (and a stop loss will be placed at that point).
For example a trader has $1000 USD account and he places a buy order of 4000 units on EUR/USD, which will give him on average $0.40 cents per 1 pip. Since 2% risk that he is willing take equals $20 USD ($1000 * 2%), calculations will be next: $20 / $0.40 cents = 50 pips is the limit for this trade.
Chart based stop
Used by many traders, this stop relies on different chart patterns, indicators and signals received when analyzing the market. There are many styles and techniques
associated with different Forex trading systems.
There are several approaches to placing protective stops:
- stops based on swings high / low,
- stops using trend lines,
- Fibonacci related stops, etc.
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