With good money management, a good trader will make money.
With bad money management, a good trader will eventually lose money.
With good money management, a bad trader will eventually lose money.
With bad money management, a bad trader will lose money very quickly.
It is estimated that just 3% of all traders make money trading
“The key to sustained successful trading is money management”.
This statement is unequivocally and undeniably true. It is an FX constant. It applies equally to the seasoned professional trader and to the raw novice. Every trader no matter how long they have been trading will be aware of those two words………………………………so why do most traders ignore, it particularity novice traders?
Clearly, if you don’t know how to trade, all the money management skills in the world aren’t going to help you but FX trading is not just a matter of deciding if a currency is going to fall or rise against another currency.
Two novice traders employing a high probability trading method and both counter trading each others positions (when one buys, the other sells) will most likely both lose money. Two professional traders with the same high probability trading method and both counter trading will most likely make money. Why is this? The answer is money management and having the discipline to maintain good money management techniques.
Not everyone who follows my methods will become a successful trader. The discipline you need to adhere to strict money management practice is tiresome and burdensome. Its a bit like sticking to a healthy diet and exercising. You have to take losses when you are trading. Losses are part of trading. No-one can be right every time. It’s how you manage those losses that will determine whether you will succeed in trading.
Let’s start at the beginning and assume you have never traded before. You’ve opened a demo FX account and you’ve been doing well. You have a method that seems to work and works regularly and you think its time to open a live account.
Think money management.
How much money have you got in liquid assets? Lets say you’ve done the sums and you have £25,000 disposable income. Money management starts here. Let’s say you open an account with the full £25,000. Your thinking is that if you have money that’s in a bank earning 2% p.a. or less then it may as well sit in a broker account available for trading. If you are a novice trader, you have made your first mistake. The first rule of money management is never expose your account to a risk greater than 2%*. That doesn’t just mean a trade or trades greater than 2%, it includes the account itself so if you have £25,000 then you should open an account with 2% of £25,000 which is £500 if you are trading mini-lots (which you will be – more on this later).
If you do that and your broker goes broke or you place a losing trade with 8 mini lots when you meant .8 mini lots or you went LONG (BUY) GBP/CHF at 07:55 on the 15th January 2015, 5 minutes before the S.N.B. (Swiss National Bank) abandoned the 1.2000 EURO floor, you have only lost 2% of your liquid assets and you are not financially crippled. You live to fight another day.
(* throughout this article I am going to recommend a risk not greater than 2%. Some professional traders would say that is too high and recommend 1%. I wouldn’t necessarily disagree with that but I believe you need a little flexibility and 2% will give you enough scope for experimentation. If your method proves to be successful and your account balance increases, you can increase your risk accordingly).
Now, as I’ve said, this advice on your starting account balance is for novice traders unaware of the pitfalls of trading. Without guidance, all novice traders will lose their money. Its inevitable. Unless you are exceptionally gifted or lucky every trader will have at some time in their lives received a margin call on their account (insufficient equity to trade). For more seasoned traders who may have lost their account through unfortunate circumstance (like some unexpected one off event like the crash of 2007 or the previously mentioned S.N.B. rate decision) you may wish to deposit a greater percentage of your assets in order to increase your risk/reward.
2% maximum risk
A 2% risk to your account is manageable if you have a reasonably sound trading method. A 25% risk to your account is not manageable.
If you have a £1000 account and you have a 100:1 leveraged account (I’ll explain more about leverage later) and you open a standard position of .5 lots you are trading at £5 per pip. Your position only has to move 50 pips against you for you to be £250 out of position. A loss of 25% of your account is debilitating and means you would need a gain of 33% to restore your original equity. Should you lose 50% of your account then you would need a 100% gain on your balance to restore your original equity which is a feat accomplished by less than 1% of all the traders in the world. On a £1000 account, if you lose 2% you have lost £20.
On the table on the left, you can see that even if you had 40 consecutive losses risking 2% per trade you would still be left with £445.00 in your account. However, if you increased the risk to 5% and had 40 consecutive losses the table of the right shows that you would be down to just £128.51.
You must remember that learning how to trade the FX markets is NOT a get rich quick opportunity. Its more like a get poor quick opportunity if you don’t protect your account. £500 might not sound much but you should look on it as practice money. There is a world of difference between trading a demo accounts where the broker will encourage you to win by reducing or removing spreads and you’ll not suffer from slippage and trading a live account where the broker will do everything he can to relieve you of your money.
In order to open any position when trading, you need to have the margin in your account to cover the position. Leverage is commonly worked out as a ratio. 100:1 leverage (most common) is equivalent of a margin of 1% (1/100 = 0.01 or 1%). Therefore you must have 1% of the total exposure of the position in your account to place the trade and maintain the trade. I’ve stressed “and maintain” because if your trade is going against you then ultimately you will not have enough funds in your account to maintain the trade and you will suffer from a margin call and the position will be closed and you will have lost most of your account. One small benefit of a margin call is you can never lose more than your account and a margin call will always leave you with some money in your account though not enough to trade at the position size that resulted in the margin call. Many brokers offer a range of leverage to suit your style of trading. Personally I stick with 1:100 but City Index for example offer ultra low risk of 20:1 25:1 50:1 100:1 (medium risk) 200:1 250:1 300:1 and even 400:1 which is very high risk. Its even possible to trade at 1:500 leverage which sounds attractive to be able to trade $100,000 with just $200 the risk is prohibitive as should the trade move against you would be margin called and your account would be emptied.
You want to SHORT (sell) GBP/USD and the price is 1.5227/1.5229. The 2 pip difference is the spread which is the dealer margin. If you sell, you are selling at 1.5229 and the price needs to move to 1.5227 before you are at break even and if you buy (go LONG) then you are buying at 1.5227 and the price needs to move to 1.5229 before you break even. You are trading with a leverage of 1:100. The deposit/account balance you would need to open a trade would be £100,000/100 = £1000. In order to accurately calculate the risk we need to convert this into USD so £1000 x 1.5228 (mid rate of the currency being sold) = $1522.80. So you would need either £1000 or $1522.80 margin to place and maintain this trade if you were trading at one standard lot which is $10 per pip. What is more, should the position move just one pip in the wrong direction you would get a margin call and the trade would close.
If you were trading mini-lots (a mini-lot is 1/10th the size of a standard lot so 10 mini-lots equals 1 standard lot) you would need £100 or $152.80 to open and maintain the position and if you were trading micro-lots (a micro-lot is 1/100th the size of a standard lot so 10 micro lots – 1 mini-lot and 100 micro lots = 1 standard lot) you would need £10 or $15.28 to open and maintain the position) so its obvious that no novice trader should ever be trading using standard lots.
Trading with standard lots means if you wish to buy $100,000 you are buying a standard lot with 100,000 units as your trade size.
Trading with mini-lots means if you wish to buy $10,000 you are buying a mini-lot with 10,000 units as your trade size.
Trading with micro-lots means if you wish to buy $1,000 you are buying a micro-lot with 1,000 units as your trade size.