Forex trading is nowhere near easy, especially for newcomers. You need to consider a large number of aspects when it comes to turning yourself into a successful trader. One of these aspects is money management, which is extremely important if are looking to start making profits, instead of just trading for fun.
While money management, in general, refers to developing a strategy that helps manage your income and expenses, when it comes to forex, it represents a slightly different thing. In forex, money management represents a set of guidelines that traders develop, in order to minimize losses and maximize profits.
If you are new to forex, still trying to figure out what pips, leverage, and margins are, money management may seem quite difficult at first. By following the tips below, you will have a much higher chance of minimizing losses and growing your account ever since the beginning of your trading journey.
Table of Contents
Ensure you have a steady income
It is safe to say that forex trading made many people rich, some even managing to make $1 billion over-night. But not everyone is as good a trader and speculator as George Soros or Andy Krieger, so before giving up your job to become a billionaire, you may want to think twice.
Maintaining a steady job means you will have enough money to cover your daily expenses and, of course, trade. Don’t just quit your job the moment you started making successful trades, as the world of forex trading is, at the very least, unpredictable.
At the very beginning, treat forex like a hobby, try to learn its basics and don’t put too much pressure on yourself. You are effectively building a forex mindset to help you succeed in this endeavor. The last thing you want is for trading to affect your job or future career. Try to observe how the market fluctuates and how it affects your trading decisions, but don’t put too much pressure on yourself.
Don’t invest money you don’t have
The first rule of trading, be it currency trading, or any other form, is to only invest money you can spare. This means that paying your bills comes before topping your account. No trade is 100% guaranteed to succeed, so when investing, think of that money as money you may no longer have.
Try to keep an income and expenses diary, not only for your trading account but for everyday financial management. Set monthly limitations of how much you can afford to invest and stick to those limits. There is no point in sacrificing hard-earned money and risk losing the money you need to live.
A great way to limit your trading money is to set up a PayPal account and deposit money in it for your trades. There are many forex brokers that allow you to fund your Forex trading account via PayPal, and this way, you can set clear limitations. For example, if you deposit $1000 on your PayPal account, this is the amount you will trade this month. If you were to link your bank account to your trading account, it will be much easier to lose track of expenses and end up spending more than you can afford.
Set a risk/reward ratio
The risk-reward ratio (RRR) is used to determine the prospective reward you can earn for every dollar you risk on a trade. Expert traders recommend that, at least in the beginning, you should set a risk/reward ratio of 1:3, meaning you are willing to sacrifice one-third of what you are about to win.
The RRR is usually set based on each trader’s risk tolerance, meaning what works for others may not necessarily work for you.
Many traders set stop losses, and we’ll get to what it means pretty soon, to ensure they don’t end up losing too much. Stop losses go hand in hand with the RRR, as in order to determine the risk you are taking, all you need to do is divide the capital you are about to risk with the pip stop loss.
If, for example, the distance between the entry-level and stop-loss is 30 pips, and the distance between the entry point and take-profit is 90 pips, it means you will be risking 30 pips to win 90, which brings your RRR to 1:3.
Always use stop losses
Once you learned a bit more about money management, it is time to start understanding and using stops, to help minimize risks and maximize profits. You will want to consider one of the following types of stops:
- Equity stop: the simplest type of stop to consider, meaning the trader will choose to risk a fixed amount of their account for every trade they make. Usually, traders use a 2% stop, meaning that, for any type of trade, you will not risk more than 2% of your total money. Some more experienced traders, that use a more aggressive technique, may go as far as 5%, but it is not recommended during the early stages of trading.
- Chart stop: traders who focus more on technical analysis may prefer using chart stops, or combining chart stops with equity stops. A simple example of a chart stop is using the swing low or high point, which can be combined with an equity stop to ensure the trader does not lose more than 2% of his account.
Traders can also choose volatility or margin stops, but those are more complex and risky strategies that require a profound knowledge of the market.
Emotions and money don’t go well together
Last, but not least, no money management tip will be helpful if you don’t learn to leave your emotions at the door when trading. Emotions are normal human traits, but when you risk big, they can sometimes get the worst of any trader.
If you notice emotions getting in the way of making educated decisions, it may be time to step aside and take a break. Letting your emotions take on and guide your decisions means you may risk losing big, and you don’t want that.
By learning to control your emotions and manage your money, you will be on the right track to becoming a successful currency trader and make steady profits.