Those who are planning to kickstart their trading journey in the forex market must go through the process of learning about the market and trading concepts. This learning period is crucial for preparing yourself to deal with the volatile market conditions and make profits out of it. Risk management is a relevant skill you should develop before entering the constantly fluctuating currency market. Another important skill that many beginners forget to learn is money management, and this article includes the top 10 forex money management tips that every trader should know about.
Before we get into the top 10 money management tips, you need to understand the meaning of money management and why it is relevant in forex trading. In simple words, money management is the way in which a trader uses their funds for trading. Basically, it is a set of techniques and methods that a trader follows for securing their trading capital and growing their account. Risk management in forex is closely related to money management, but the difference between the two is that risk management solely focuses on minimizing losses, while money management focuses on the optimum utilization of funds for trading.
Now, you may wonder about the relevance of money management in forex trading, as we already have risk management to limit potential losses. But the scope of money management is wider, and risk management is just a part of it. As a trader, you must learn about forex money management because having market knowledge or trading skills is not enough to grow your account over time. These skills can only help you win some trades, but your actual gains as a trader have more to do with how you manage your funds or trading capital.
Being a forex trader, how can you manage your funds in the best possible way? The answer to this question is the top 10 forex money management tips that you should follow for building a successful trading career in the long run.
The first money management tip for forex traders is to take some time to assess their risk and decide the risk they are willing to take for a trade. The percentage of trading capital that you are risking while entering a trade will be your risk per trade. The ideal risk per trade for a forex trader is 2%, which means the maximum amount you can risk for a single trade should be 2% of your total trading capital. This is done in order to limit your potential losses and overall account drawdown, as risking a higher percentage would result in greater losses. The 2% rule is one of the most effective money management techniques to preserve capital.
The second tip for money management in forex trading is about the number of trades you enter in a single day or the timeframe you follow for trading. Each and every trader should set a limit for the maximum number of trades they can open, irrespective of the results. That means you should stop trading once you reach the limit, whether you are winning or losing. Entering too many trades without a solid plan is referred to as overtrading, which can quickly drain your account. So, always follow a disciplined approach and don’t give in to your urge to place extra trades after consecutive wins or losses.
The 3rd money management tip for forex traders is letting your winning trades run longer and closing the losing trades right away. In trader’s language, it is about cutting your losses as early as possible and giving your trade time to make profits as long as it can. When you see the market move against you, resulting in losses, you should not hesitate to exit that position. Sometimes, you close the trade for a small profit only to regret it later, as you could have made a bigger profit if you had decided to wait a little longer. So, you must be patient to make the most of a winning trade.
This is not just a tip but a rule that all traders should follow without fail. A Stop Loss is an order that ensures you automatically exit a trade when it results in losses. You just decide the maximum loss you are willing to take for a trade and place the Stop Loss at that level for an automated exit without delay. The Stop Loss should also be set at the right place so that it does not limit your profit potential. The profits and losses in forex are often measured in pips, and a pip value calculator would be a perfect tool to determine the monetary value of pips in your base currency. Such automated tools can come in handy for calculating the best Stop Loss levels.
This tip is closely related to the first tip of deciding risk per trade. The position size or trade size tells how much money you will be risking for a trade, and optimal position sizing is a crucial component of forex money management. In fact, perfect position sizing is a must for maximizing your profit potential while limiting your risk per trade. The position size or trade size is determined by the type of lot and number of lots you trade with. If you find it hard to decide upon the ideal lot size, you can take the help of a profit calculator and check the potential profits or losses with different lot sizes and choose a lot size that suits your risk profile.
The next tip for money management is setting an optimal risk/reward ratio and entering trades based on it. As the name suggests, the risk/reward ratio tells about the amount of risk you are taking for a trade in relation to the trade's profit potential. The amount of profits you can make from a trade is the reward, while the amount of loss you can suffer by losing the trade is the risk. Your risk/reward ratio should always be greater than 1, and if the trade has a lower risk/reward ratio, then you should not be entering that trade.
Leverage is a very powerful tool to accelerate your profits in the forex market. It allows you to take up bigger positions with a smaller amount of trading capital as a margin requirement. But trading with leverage also increases your risk as your losses become bigger. So, using excess leverage in Forex trading is dangerous for a trader as they may lose much more than they can afford. So, you should be using leverage within limits to maximize your gains in a safe way.
When you are handling money, emotions like greed and fear also come into the picture, as it is human instinct. Being greedy for money and being fearful of risking money is quite common among traders. However, these emotions are not at all helpful in the trading process. So, you must take control of these emotions instead of letting them take control and relying on logic while making trading decisions.
Another forex money management tip is to use trailing stop-loss orders to lock your profits in a trade. A trailing stop loss is different from a regular stop loss. A regular stop remains unchanged, while trailing stop loss can move on its own to preserve your profits in a trade. So, placing a trailing Stop Loss in your trades. But you need to be careful about the placement of trailing Stop Loss as it will be moving in an automated manner.
The last tip for forex money management is studying correlated pairs, as currency pairs often end up being correlated in the forex market. This correlation can either be positive, where the prices of 2 pairs move in the same direction or negative, where the pairs move in opposite directions. Those who trade with multiple currency pairs should always check the type of correlation and the degree of correlation of the pairs they are planning to trade with because trading without understanding currency correlation can be risky at times.
So, these were the top 10 tips forex traders should follow for managing their funds in the best possible way. Most of these tips are related to risk management, as taking calculated risks is the essence of efficient money management, and this is the key to long-term success in forex trading.
