Money Management And The Understanding Of Risk

The Forex market has a downside: you could lose. But even the downside has an upside: you can’t lose much. If you pay attention to the principles of Forex money management, you can control how much you lose. And even if you lose half the time, in this market you can still make a profit.

First of all, understand this: you will lose sometimes, because in this or any market, everyone loses sooner or later. No one is perfect and no one calls every trade perfectly. There is no magic software or enchanted system that is right all the time, no matter what the sales materials say. So be prepared, before you ever begin trading, to lose some money.

But in the Forex market, you can only lose the price of the lots you purchased. Although that amount varies from broker to broker, in a mini account the average purchase price of one lot is U.S. $100.  And that’s it; $100 per trade is the absolute maximum amount you can lose per trade. If the trade goes south and the market moves against you, even if you set no stop-loss at all, the market maker or your broker will close it when the loss reaches $100. This is meant to protect their investment, but it protects you, too, and the equity in your account. That’s why, in the Forex market, you will never get a margin call from your broker to cover a questionable position.

But you don’t want to follow a losing trade all the way down until the broker closes you out; you want to limit the amount of money you lose. And by properly setting a stop and limit to each order, you can do just that by controlling how far down you follow a losing trade. You set the bail-out point, and when the market reaches that point it automatically closes your order.

Set your stop far enough away from the purchase price that it’s not triggered by normal market jitters, but not so far away that you lose more money than you’re prepared to risk. On the charts, pay attention to the support and resistance points if the market is range-bound. Remember that even if the market breaks out of a range, the previous low price is likely to become the new high price in a bear market when prices are dropping; and the previous high price often becomes the new low price in a bull market when prices are rising. Setting your stop at these points is a wise move.

On the other hand, by setting your limit at least twice as far from the entry point as the stop, not only do you control the amount you lose, you also control the amount you earn. And when the trade goes your way, you earn more than twice the amount that you lose when it doesn’t.

So even if you’re only right half the time, with proper money management techniques that’s all you need to make a profit in the Forex market.