How Important Is Money Management?
The ultimate difference between a professional trader and an amateur trader is simply their perspective on money management. Like dieting or working out, traders do know the importance of money management but they hardly practice this in real life. The reason is, it takes time to understand how they should manage money. They have to continuously monitor their account and keep them updated with the recent events.
Without proper money management, Forex trading can be very risky as it takes huge time to recover from a big loss. The following table shows you how difficult it is to recover from a loss:
Amount of Equity loss
Amount of return necessary to restore to original equity value
There are many incidents occur with traders who didn’t take money management seriously. Some traders lost everything because they didn’t plan their money management. Most of the new traders start trading with high hopes and visualize big dreams. In reality, hardly any traders take precautions to save their money from losing. With the hope of Big Win, traders can fall in great loss.
Traders can prevent themselves from losing by using Stop losses. A day trader and trend follower Larry Hite of “Market Wizards” book said that traders should not take more risk than 1% of total equity on any trade. It means that no matter what the trade is, traders should risk 1%.
The reason behind doing this is- a trader can still have 80% of their equity even though they become wrong for 20 times.
Here are some tips for money management:
Calculate your risk capital:
Calculating risk is a part of the trading process. If there’s any chance of lower profit compared to profit to be gained. To measure the risk properly, traders can use the trading calculator.
Try to be realistic:
A common reason that often let down new traders is their expectation is not realistic. They enter into this market thinking that there’s no loss and they want to make money as quickly as possible. But best traders think about consistency. They plan to stay in the game for the long run. They know that they can’t control the market and thus make realistic goals.
Stop loss is one of the major precautions you can take to save your account. It acts as a protection for your investment. As in the Forex market, there’s always a possibility of loss, you can set your stop-loss order not to exceed more than 2% of your trading balance for any given trade.