Money Management - Basics
If you consider being a successful trader, your trading program must take into account three major factors: 1) Trading System 2) Trading Psychology 3) Money Management The first factor is already fully covered for you by our Forex SMS Free Signals! While we will talk about Trading Psychology other time, let's focus now on Money Manegement.
Money Management is very often an overlooked subject and many traders (both beginners and experienced ones) just fail miserably - not because of their trading system (which can be really efficient), but because of really bad Money Management.
Money Management is the area of your system that will have the biggest influence on the bottom line - your profits. Money Management is the difference between poor performance and great performance - the difference between going broke and being a successful investor. Even when you open a buy position in an uptrend, without smart Money Management you can hit Stop-Out due to retracements.
With ForexSMS.me you will learn now how to properly manage your funds in your forex real account, so you can fully take advantage of our forex sms free signals and be such a successful trader.
In forex trading, Money Management covers the following areas:
- Portfolio make-up
- Using Stop-Loss
- Reward-to-risk ratio
1. Portfolio make-up (general guidelines to Money Management):
- You should invest maximum 50% of your current balance. E.g. if you have 10,000 USD on your trading account, only 5,000 USD should be available for trading purposes. The rest of funds remain as a reserve during periods of adversity and drawdown.
- Total margin used for any group of financial instruments should not exceed 25% of your equity. E.g. gold and silver belong to the same group of previous metals and often trend in the same direction. If your total equity is 10,000 USD, you should not invest more than 2,500 USD in them in total.
- Total margin used for any financial instrument should not exceed 15% of your equity. E.g. if you are trading on EUR/USD and your equity is 10,000 USD, you should not invest more than 1,500 USD on that currency pair.
- Total amount risked in any financial instrument should be limited to 5% of your equity. E.g. if you have 10,000 on your trading account and if you have opened position on EUR/USD, you should close that position at latest when it makes you lose more than 500 USD.
It is strongly recommended to use Stop-Losses with EVERY trade you make. While we are providing you with great forex SMS signals that may be for you highly profitable, some trades can generate losses and that is why you need to cut those losses short. Using Stop-Losses is obligatory in a great performing forex trading system.
How to calculate the size of the position when using Stop-Loss:
Let's say we are having 10,000 USD on our trading account with a leverage 100:1 and we are have just received a forex SMS signal to buy EUR/USD (current price: 1.35500) with Stop-Loss (SL) at 1.35000.
Difference between 1.35500 (open price) and 1.35000 is 0.00500 which is 500 points (50 pips). We know already that the maximum loss we can afford is 500 USD (5% of our total equity), so 50 pips should generate a maximum 500 USD loss. 50 pips = 500 USD ---> 1 pip = 10 USD 1 pip equals 10 USD profit/loss in the case we open a position of a size of 1 lot (100,000 EUR in this case).
As we are having a leverage by our side, instead of putting 100,000 EUR, we only need to invest: 1 lot * 100,000 EUR / 100 (leverage) = 1,000 EURO 1,000 EUR is (by the current market price 1.35000) around 1,350 USD
Now you see in the case above, that with 5% risk tolerance and 10,000 USD as total equity, we should invest 1,350 USD to buy EUR/USD with Stop-Loss set-up 50 pips below the open price.
3. Reward-to-risk ratio
You can never allow your trades to generate totally more losses than profits. If you do, then you are going broke.
So, what to do if some of your trades are generating losses? This brings us to the question of reward-to-risk ratio. Reward-to-risk ratio should be crutial in your investing pattern. We are providing you with free forex SMS signals, however please remember, that some signals may be wrong and it is strongly recommended to cut losses short. For the rest of them, you should let profits run.
You need to make sure that the dollar amount of the winning trades is greater than that of the losing trades. To accomplish this, most traders use a reward-to-risk ratio. For each potential trade, a profit objective is determined. That profit objective (the reward) is then balanced against the potential loss if the trade goes wrong (the risk).
A commonly used yardstick is a 3-to-1 reward-to-risk ratio. The profit potential must be at least three times the possible loss if a trade is to be considered. E.g. if you open a buy position on EUR/USD at a prive 1.35500 and you set up your Stop-Loss at 1.35000, you should place Take-Profit at 1.37000. If you can risk 500 USD on a single trade, you should let profits run for this trade to 1,500 USD.
- Let profits run, cut losses short.
- Always use Stop-Losses to limit losses.
- Use Money Management guidelines.
- Use at least a 3-to-1 reward-to-risk ratio
- Study Money Management on a daily basis.
Keep learning until you master it! Most of the forex traders focus only on technical analysis avoiding Money Management and that is why they are losing. Once you master Money Management, you will fully take advantage of free forex SMS signals and you will become a successful trader!