Money Management

Money management is about the proper application of the points we discussed: Capitalize the account sufficiently, do not over-leverage, be disciplined about profit taking, and avoiding losses. There’s nothing that difficult about doing this. In general, decisiveness about one’s plans, and prudence about taking risks will grant the patient trader success in a manner that might even be surprising for him. We must remember that a successful trader (unless his success is the result of extraordinary times and conditions) is not a flashy, exciting, boastful, or prodigious being: in many cases he’s just a cautious, patient, modest, calm individual with good but not exceptional intelligence. His success is not the result of some very esoteric knowledge, revolutionary trading method, superhuman insight or intuition: but rather it’s about diligence, hard work, and humility.

In the previous three parts we discussed what you, as a trader, should not do. In this section we’ll take a brief look at the rules of money management.

The core in a successful money management strategy

Taking profit, and stopping losses are the two concepts that form the core in a successful money management strategy; do not let greed erase your profits, and do not let pride prevent you from exiting a position that is proven to be wrong.

Entering a stop-loss or take-profit order is rather simple since in almost every trading software the program will prompt you to enter these orders as soon as you make a trade. In general, unless a trader has a clear schedule for the duration of his position based on fundamental analysis, a take-profit order is a must. A stop-loss order is almost always a must however, regardless of the basis of your analysis. Of course, the stop can be wide and tight at the discretion of the trader, and if there are good reasons behind the position you take in the first place, persistence against market swings can be appropriate and rewarding. The key point that distinguishes foolish persistence from logical resilience is that the fool persists because he’s afraid of realizing losses, while the successful trader keeps to his position based on his analytical skills which were acquired after the realization of countless stop-loss orders during the learning process.

Base stop-losses and take-profit orders on logic

As with everything else, the trader must base his stop-losses, and take-profit orders on reason and logic, not on any kind of intuition, sixth sense, or emotional matter. The nature of forex is such that, due to constant volatility, even a well-conceived, and well-thought position will at some stage have to be in the red. Provided that we don’t revise our initial purposes and schedules based on fear or euphoria, there’s nothing wrong about that, and the trade should always be allowed to run its course, if the causes that led to our decision remain intact. If they are gone, the trade should be discarded too. But if the reasons are still valid, we shouldn’t be afraid of unrealized losses: we placed the stop-loss order at where it is only to allow the position to run its course.

The successful trader is conservative

We mentioned before that regardless of our political or social persuasion, we must choose to be boring and conservative to achieve success in trading. Successful money management always aims at the preservation of capital, not necessarily great profits. We already detailed many of the reasons for that conviction, but another reason for our conservatism in taking risks is provided by the fact that it’s a lot timelier and costlier to repair a mistake in comparison to the time it takes to commit it.

To give a very simple example: supposing that through reckless errors we lose about half of our account while trading, what would be the profit ratio we’d need to repair the mistake and get back to our beginning capital? Say we begin at 100 USD, lose ½ of it, and end up with 50 USD. We’ll need to double our account just to get our losses back. In other words, for a fifty percent loss, we need a hundred percent profit, just to mend the damage caused by recklessness. With such facts standing against cavalier behavior in the markets, how can we avoid being conservative in trading?

10 tips for successful trading

Here are a number of time-tested methods the trader can employ in order to minimize his losses, and to achieve a moderately successful long-term career.

1. Do not take a trade if you can’t back it with very convincing reasons. Your capital is precious, and it’s limited. Opportunities in the forex market are limitless, and there’s always another chance, if you (and your capital) are there to take it.
2. Do not trade on others’ opinions, unless you understand and agree with them. We emphasized repeatedly that understanding what we do is the only way to gain confidence in our actions and minimizing the role of emotions, and we won’t learn anything without understanding what we’re doing.
3. Do not change your stop-loss, or take-profit points once you enter them. If the reasons behind the trade are gone, discard it. If they remain, let the trade run its course. Sit back, and forget about it. Concentrate on your education. Remember, panicking will not gain you a dime, and however long you stress about your success or failure, the market will do what it wants: you cannot influence its decisions. Stress will ruin your nerves and wreck your career, but won’t better your chances of success, and will not save you from realizing losses on an erroneous position.
4. Do not expect your stop-loss order to absolve you from faulty analysis. The stop-loss order is not a safety valve to care for the mistakes of a lazy analyst, it’s only a mechanism for recognizing that your analysis was wrong. Thus, if there’s no good reason for the trade in the first place, the stop-loss order will be completely useless, regardless of how tight or wide it is..
5. Do not be enthusiastic, do not be fearful. Neither will help you. Forex is not a game, it’s a business, and you have the responsibility for your choices. There’s nothing magical about it.
6. Do not hurry to take profits, and tarry in liquidating an outdated position which the events have proven to be erroneous. Taking profits and stopping losses should both occur when the events provide the reasons for doing so, or the price action forces you to make choices.
7. Do not use high leverage and tight stops together, as that is the fastest path to a wiped out account. Instead employ low leverage to control your risk, and use stop-loss orders to manage volatility and price swings. To repeat, use low leverage to ensure that when you make a faulty analysis, the results are tolerable; and use wider stops to ensure that the position can absorb random price swings.
8. Do not average down, do not add funds to a losing position. If you have confidence that the position in red will eventually turn black, let it run its course, but do not ever add to it. Let time show you if your analysis was right or wrong, but do not attempt to fight the market by haughtily increasing the size of your losing position in order to average down the starting the price. Do not increase your risk while you’re in the red.
9. Scale in. You can use multiple entry orders on top of each other as the trend moves in the direction you anticipate. As your first order makes a decent profit, set its stop-loss order at the entry price, enter a second order in the same direction, and repeat as long as the trade is successful.
10. Do not gamble. Do not use casino strategies in a financial business.

Key Points

• Money management is a key part of being a successful trader.
• Placing stop loss and take profit orders is a very important part of every trade.
• Stop loss and take profit orders should be placed according to the trader’s analysis.
• Trades should be allowed to run their course and not be closed early because of unrealized losses
• The aim of money management is to preserve trading capital and reduce unnecessary risk.

Further Reading

• What is Risk Management?
• Key Risk Management Principles
• Money Management Articles.