What is Money Management?

Although you may think the title of Money Management is pretty clear and easy to implement – how to manage your money and invest wisely – it is slightly more than that. It is the educated process of how you save, invest, budget and spend domestic income. This can also fall under the topic, overseeing money usage for a business, too.

Everyone in some form or another practices money management in day-to-day life, whether in their personal capacities or with investment management such as trading. Trading forex and CFDs successfully does require discipline. You will need a proper knowledge of the basic elements that are vital if you are expecting long-term gains from this industry.

Practice money management rules on a demo account or open a trading account and start implementing what you’ve learned.

Inexperience is possibly the main reason for traders losing money in forex and CFD trading. Neglecting your money management principles and emotional trading increase risk and decrease your reward. As forex is extremely volatile at the best of times, therein lies an inherent risk, and having correct money management skills are essential when entering the markets.

Risk Management

When entering into a forex or CFD trade, there needs to be a certain understanding that you will enter risky situations and accept this as a prerequisite for leveraged trading. There are many risks when trading; however, there are just a s many ways to reduce these risks.

While your profits are generally connected to the risks, here are a few principles:

  • Practice position sizing
  • Recognize your trading risks
  • Analyze and evaluate those risks
  • Establish solutions to reduce those risks
  • Apply and manage those solutions on a constant basis

Position sizing can be approached in a few ways, as simple or complex as you choose, as long as it is best suited to your platform. This way you are able to easily manage both the losing trades and the winning ones. There are three models we can follow

Fixed lot Size

A great way for beginners to start their trading careers. This means that traders will trade with the same position size, probably small. Lots can be changed during the trades according to how the account increases or decreases during the trading period. The account size is important when starting out – keep it small and use a leverage of 2:1. This way you can steadily grow potential profits over time.

Equity Percent

The idea behind Equity Percent is based on the size of your position as a function of the percentage change in equity. It is best to determine the percentage of equity for every position and this will determine and allow for growth of equity in relation to position size. One can always increase the percentage of equity used for every trade, but it is not without mention, that the higher the profit potential, the higher the risk.

Practice money management rules on a demo account or open a trading account and start implementing what you’ve learned.

What is a safe percentage of equity to trade with?

It is often advised to trade with a smaller percentage of equity such as 1% or 2% that equals 50:1 leverage per trade, also allowing you to stay in your position for a longer period of time.

Simply put, keep the size of your trades proportional to your equity. If you enter into losses, the position size is reduced preserving the account from depleting to a zero balance too rapidly. One can also reduce the size of the initial trade when you enter a losing streak to minimize the equity damage.

Remember that breaking even after losses takes more time than losing the same amount.

Advanced Equity percent with stop loss

The methodology behind this technique is to limit each trade to a set up that is a portion of your total account equity. This is often between 2-10%. This method differs from Fixed Ratio in that it is used in trading options and futures and helps you increase your exposure to the market while protecting your accumulated profits.

Guidelines for setting daily or weekly trade exposure levels

Let’s look at a simple example: a trader’s trading balance is $1000 and he decides to risk only 2% of the balance ($20) in every trade. In case he trades a mini lot (10,000 units) of EUR/USD, then every pip is worth 1 USD. Thus, the trader should put a stop loss order if the price drops 20 pips. Losing 5 trades in a row will result in losing roughly $100.

Practice money management rules on a demo account or open a trading account and start implementing what you’ve learned.

Now, let’s say the same trader is ready to risk 10% of the budget on a single trade. He trades a standard lot of 100,000 units of EUR/USD, then every pip is worth 10 USD. In this case the trader should put a stop loss order if the price drops 10 pips (=$100) on the first trade.

If he lost the first trade, the new stop loss target is 9 pips (=$90) which is 10% of the remaining balance of $900, and so on to 8,7, and 6 pips in following loosing trades. Losing 5 times in a row with this kind of exposure will result in total loss of $400.

Number of Losing Trades (balance $1,000)2% exposure10% exposure
1$980$900
2$960$810
3$940$730
4$920$660
5$900$600

Same manner of exposure calculation can be scaled to include daily/weekly exposure levels. If, for example, the daily exposure level is 10% of the balance, then in the first example the trader would need to stop trading on the same day when he lost $100.

Risk and Reward ratios using Stop Loss

When you are ready to start trading you will open your live trading account on the appropriate trading platform and deposit your acceptable capital. Providing protection of your invested capital when forex or stocks move against you is essential and represents the basis of money management. Trading with a serious approach to money management can start with knowing a safe risk and reward ratio as well as implementing stops and trailing stops:

Stop loss:

This is the standard method for limiting loss on a trading account with a declining stock. Placing a stop loss order will set a value that will be based on the maximum loss that a trader is willing to absorb.

When the last value drops below the set amount, the stop loss will be triggered and a market order is put in place so that the trade is halted. The stop loss closes the position at the current market price and will prevent any accumulating losses.

Trailing stop:

With a trailing stop there are more advantages when compared to the stop loss and it is a more flexible method of limiting losses. It allows traders to protect their account balance when the price of the instrument they have traded drops.

An advantage of the trailing stop is that the moment a price increases, a ‘trailing’ feature will be set off, permitting any eventual safeguard and risk management to capital in your account. The main benefit of a trailing stop is that it allows protecting not only the trading balance, but the profits of the ongoing trade as well.

Practice money management rules on a demo account or open a trading account and start implementing what you’ve learned.

Risk and reward ratios

Another way you can increase protection of your invested capital is by scaling profit to three times more than you will risk. Give yourself a 3:1 reward-to-risk ratio. Based on this you should have a significantly greater chance of ending up with a positive return.

The main idea is to set the profit target 3 times larger than the stop loss. For instance setting a take profit order on 30 pips away from the current price and a stop loss at 10 pips away is a good illustration of 3:1 reward-to-risk.

Keep your reward-to-risk ratio on a manageable scale. Here is an easy illustration of the reward-to-risk ratio to better understand it:

10 TradesLossWin
1$1,000 
2 $3,000
3$1,000 
4 $3,000
5$1,000 
6 $3,000
7$1,000 
8 $3,000
9$1,000 
10 $3,000
TOTAL:$5,000$15,000

Money Management tips with Friedberg Direct

Whether you are a day trader, swing trader or a scalper, money management is an essential restraint that needs to be learned and implemented per trade opened, no matter your trading style or strategy.

Implement money management techniques or you increase the risk of losing your money. These tips are basic and easy to follow when trading and in risk management:

You should never invest what you can’t afford to lose

First rule of thumb is never fund your account with money that you don’t have. Remember that if you can’t afford to absorb the losses of the invested capital then do not fund your account with money that you can afford to take a loss on. Trading is not a gamble, it needs to be entered into with educated decisions.

Stops and limits are meant to be implemented per position

As your broker we advise you to set stop loss orders. Take them as seriously as you do your investment, trading should be done with precision and not luck. You need a stop loss for every trade; it is your safety net that will protect you from big price moves.

When you profit

When you reach your target profit, close the trade and enjoy the gains from your trading. Withdrawing from Friedberg Direct is simple, fast and safe.

Open your account and enjoy all the benefits and trading advice from market professionals. Test our services on your risk-free demo account.

Setting your stop loss and take profit orders

One of the most basic of trading principles is how to set your risk-reward ratios properly. This can be done by establishing where you can define your trade is going, how far the market will go in your favour. Having this number in mind sets the tone for organizing your Stop Loss (S/L) and Take Profit (T/P) orders.

As we mentioned, the traditional ratio in currency trading is 3:1 for the beginner. For the more experienced trader this can be increased to a minimum of 4:1 but never above 5:1.

Steps for setting up your S/L and T/P:

  • Write down your target profit in pips. This number can be either arbitrary or derived from forecastable price levels and current market price.
  • Take the number from the previous step and divide it by the reward-to-risk ratio to calculate the maximum allowed negative price movement.
  • Now you are ready to set up your S/L and T/P orders, by taking the numbers of your target profit and tolerable risk values, and calculating the distance from the current market price (in pips) for both the risk and reward value. From these two numbers, determine your Stop Loss and Take Profit levels.

Practice money management rules on a demo account or open a trading account and start implementing what you’ve learned.

To illustrate the aforementioned rules here’s an example:

The EUR/USD is trading at 1.02660.

We assume that the market will trend upwards, and we want to ride the trend since we believe that the market will rise to 1.02760 at a minimum.

From our target price of 1.02760 we subtract the current market price of 1.02660:

1.02760 – 1.02660 = 100 (pips)

To calculate the value in pips of the risk factor based on a 3:1 reward/risk ratio we divide the total number of pips (100) by the reward ratio (3) = 33.33 pip (risk)

We have easily worked out the risk and reward targets and now we set the S/l and T/P levels

Finally, to calculate the final stage take the current market price and subtract from it the risk value. Then add the reward value to the current market price and the final figures will be the S/L and T/P.

1.02660– 0.00033 = 1.02627 S/L

1.02660 + 0.00100 = 1.02760 T/P

Learn and Trade with Friedberg Direct

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We recommend you to visit our trading for beginners section for more articles on how to trade Forex and CFDs.