Trading requires a lot of patience, proper training, quick adaptation to market updates as well as other qualities. However, this does not guarantee success, as there are many risks associated with trading. To minimize them as much as possible, we can use various risk management methods.
The financial health of the trader will be measured by the way in which he is able to manage his capital when trading, whether in Forex or in other markets. Among the risk management tools that allow you to avoid common trading mistakes and safeguard your capital, the first position is occupied by money management.
Incorporating a money management plan into an overall Forex trading strategy will help protect your portfolio. Unfortunately, the way most beginning traders learn is with practice, which can lead to losses, so having a good trading money management plan is preferable.
In this article we will learn:
- What is money management?
- Why is money management in trading important?
- How to handle this trading tool? How do I do a risk management?
- How to protect our capital thanks to money management?
- How much capital to risk when we trade?
Money management – Definition
What is money management? It is an English term with which we refer to money management. It is a term used in the world of finance, especially in online trading, to talk about Forex risk management. Money management is nothing more than the ability to manage profits and invested capital with the aim of not taking risks outside of our trading strategy.
Therefore, money management trading is one of the factors that lead to success and should not be neglected, both for novice and more experienced Forex traders. A good trader has a good trading strategy and a good money management tool. Here are some simple tips to achieve good money management in trading. But first, let’s take a detailed look at the main risks that we may encounter when we operate.
1. Money management in trading – Leverage
When we choose to invest in the currency market or with CFDs, one of the reasons that motivate us to do so is the possibility of using leverage since we do not need a very large capital to start trading. Although this is a great advantage, we must handle it with common sense because in the same way that it multiplies our potential return, it will also multiply our potential losses.
Admiral Markets UK LTD Spain Branch offers Forex leverage of up to 1:30 for retailers and up to 1: 500 for Professional traders. For example, with a 1: 100 leverage you can open a trade with a nominal value of 10,000 EUR, with only 100 EUR of margin.
One of the biggest risks in money management, in this sense, is over-leverage, which is behind most of the losses of beginning traders. To avoid this, it is advisable to open several small positions even at the cost of potential profits and to set a correct level of leverage for each of them.
If you are a beginner trader, it is best to have good money management and avoid significant leverage. In fact, it is advisable to use leverage only when we are used to losing money and we know that not all orders in the market can be winners. Thus, you can avoid large losses in your portfolio as well as being on the wrong side of the market. In short, it is a double-edged tool and therefore we recommend caution in its use.
2. Money management and volatility
The volatility measured intensity changes in the asset price and is a measure of risk. The higher the volatility, the higher the short-term profitability but also the higher risk of loss. On the contrary, if the volatility is low in the financial asset, the operation will be less risky.
Be that as it may, to protect us from volatility and minimize your risks, Admiral Markets offers an advanced configuration package for any type of trading strategy. This package consists, among other things, in limiting slippage as much as possible; limit the losses of the orders that are within price gaps or avoid the activation of the order due to the widening of the spread.
3. Money Management – Fundamental Analysis
The market constantly suffers the impact of news, events, political decisions that can change the trend from one second to another. We have seen this with Donald Trump’s threats on tariffs in the trade war with China and other countries or when the Central Bank makes a decision on interest rates.
That is why it is very important to be aware of the information that is happening and to have a good economic calendar to be able to predict movements before they occur. However, we must be aware that we cannot know absolutely everything in detail or predict all movements.
4. Money management with market gap
It may happen that we find significant price jumps. These gaps or market gaps usually form when the markets are closed but sometimes there is unexpected news that impacts in this way while the market is open, which can cause orders to be closed where we do not want, even with a stop loss.
5. Stop loss in risk management
When prices move very quickly due to high volatility, a previously placed stop-loss tends to react faster than if the trader triggers it manually. With the Account type Trade. MT4. MT4SE orders can be opened with a previously established stop loss. The MT4 Supreme Edition account also has options to set the stop loss through the Mini Terminal.
To choose a suitable stop loss we must detail these questions:
- Time frame of the operation
- Price target and when do we expect to reach it
- Current account balance
- Open position
- Order size and if it matches my account size, time and current market situation
- General market sentiment
- How long does this market stay open?
6 Problems due to external factors
In our daily operations, events or accidents may occur that we cannot foresee, for example, if we suffer a power outage, a failure in the Internet connection or if we are busy and do not pay attention due to a work or personal issue.
Admiral Markets helps you manage your money
Admiral Markets has free services to facilitate your risk management plan. Real account clients can activate a free SMS alerts service through the Trader’s Office. In addition, we have a Negative Balance Protection Policy so that Admiral Markets UK will compensate for the negative balance that is a consequence of normal Forex market activities, such as gaps. For retailers, protection is unlimited and for professionals, it will be limited to £ 50,000.
Other tools available are the margin call, an alert that goes off when the margin level is too low, and the stop out, which closes open positions when the margin goes to zero.
Money management – Trade with a demo account
If you are just starting out in online trading, the first thing to do is train yourself. Currency trading, as in any activity, should not be practiced without prior training. The most advisable thing, in addition, is that you test what you have learned with a demo account. Trading in this account will allow you to set up a trading strategy, avoid novice trader mistakes and, above all, establish good money management or money management.
When you feel ready, you can start investing with a real account starting with capital that you can afford to lose. Loss is inevitable in Forex trading and it is convenient that we get used to this fact to avoid later disappointments. A basic principle of money management is not to put all your eggs in one basket, that is, to diversify our investments.
These principles are easy to follow, so feel free to apply them as they save you major losses of money.
Money management software – Risk management
The trading platforms used by professionals offer money management tools that help better manage risk and reduce your exposure to the market. Admiral Markets UK Ltd. Branch in Spain offers Experts Advisors through the Trading Terminal and the Mini Terminal, within the MetaTrader Supreme Edition. These tools allow you to:
- Place pending orders.
- Activate OCO and OCA orders
- Register order templates
- Close trading orders at once
- Separate the MetaTrader 4 charts on another screen.
- Set trading alerts
- Make lists of stock orders
- Perform partial closings based on the profit objective and define money management
- Automatically close orders
Money management – Calculate maximum loss
How much capital to risk in each trading position? How to calculate the maximum loss in a trade? To know this, it is advisable to know in advance how much you can lose and how much you can gain from the position. Our trading calculator allows you to know the size of the position, the lot, the spread, the swap and all the parameters you need to know according to the maximum loss you are willing to take, something very important within money management.
Although many seek to obtain profits as quickly as possible, it is more important to minimize risks to avoid significant losses: if we declare bankruptcy we will not be able to operate, as is obvious. The normal thing is to register some losses from time to time, but not to lose all the capital destined for trading.
A Forex trader should get into the habit of analyzing risks before placing money in a trade. Another mistake in trading is trading all day long. Beginners will try to recoup their losses by opening more positions, however experience suggests that trading excessively generates more losses than profits. You should only trade when real trading opportunities are detected.
The two golden rules in trading are: make sure you have enough money to open 40 positions and don’t risk more than 3% of your capital on each trade. This is one of the most established tips in trading.
Money management – Stress management
If we follow the previous advice, we will better manage our stress. Trade only with money that you can afford to lose, never with capital necessary to live because Forex trading is a risky practice. This will help reduce stress and avoid the fear of bankruptcy that could lead to serious mistakes.
Money management – Managing emotions
Forex trading can generate a host of emotions, from euphoria to frustration. Freeing your mind from emotional bias can help you make more rational and correct decisions. Decisions based on your emotions are the surest way to lose money.
We must take into account the psychology of trading and avoid making mistakes. Accepting a loss is very difficult and beginners will always want to try to make up for what they lost. This is the most dangerous thing about trading. For example, if you lose 1000 euros when investing 5000, the loss percentage is 20%. To cover the loss we must achieve a profit in the same proportion to return to the original amount.
Money management – Trading plan
Another very useful tool within money management is the trading plan, a ‘map’ that will guide us throughout the process and that must include a risk management plan or Forex money management. Thanks to this guide, we will be able to control our emotions more effectively and operate more sensibly, as long as we do not deviate from the plan, whatever happens.
In Forex trading, both to make our trading plan and to put it into practice, it is very useful to consult the forums and be in contact with other traders to keep up to date with the market sentiment. A Forex trader must always follow the market news and techniques that other traders use to achieve a winning strategy.
Money management – Trading Journal
Rigor is one of the terms that should guide our trading, whether we are beginners or professionals. To improve our rigor in money management, good organization is essential. In this sense, the most practical thing is to keep a ‘trading diary’, even if it is by writing the following messages on a post-it:
- Reasons why I open a position (technical and / or fundamental factors)
- Where do I place a stop loss
- What maximum loss in this position does not exceed 5% of my trading capital.
- The risk / reward ratio is equal to or greater than 1: 2 (or 1: 1, 1: 3, 1: 4, depending on the trading style).
- My accumulated losses in the day or in the week will not exceed 20% of my capital, otherwise I must stop operating.
In this way we will learn from our mistakes and we will improve our strategies and techniques.
Money management – Conclusion
In the rules of a money management plan, regarding the maximum loss that we are willing to assume, we may find ourselves with limits that are difficult to implement. For example, if we have a capital of 1000 euros with a 1% maximum loss, our limit will be 10 euros of loss per position, which can lead us to close positions prematurely. Therefore, the higher the capital available, the easier it will be to manage money and the more efficient it is.
To counteract this limit, the trader has no choice but to relax the restrictions a bit in terms of percentage of maximum loss and take a little more risk if he wants to record more interesting profits.
In conclusion, here are some of the best tips on money management:
- Calculate the risk capital with the trading calculator. This tool will provide us with the size of the position, the lot, the spread, the swap and other elements that we must know according to the maximum loss to assume.
- Avoid aggressive trading.
- Set realistic goals with a conservative approach.
- Admitting our mistakes so that we can learn from them.
- Always prepare for the worst and have a plan in place to deal with it.
- Use stop loss to protect your investment.
- Do not try to recover what was lost by opening new operations.
- Manage leverage with common sense.
- Think long term: minimize the importance of your current operation, whether it is successful or not.