Once you have measures in place to manage your risk, it is important to understand how you can make the maximum money possible from your good trades.
This is the challenge of all retail forex traders. Losing is common but very few traders elevate their trading abilities beyond breaking even because they lack the necessary money management techniques to maximise the winning trades.
We will investigate the different ways in which you can add an edge to your trading system by looking at the various money management techniques, the pros and cons and how you can apply the one that suits you best – moving your trading to a new level.
The different money management techniques are listed below:
- Fixed lot;
- Fixed percentage; and
- Fixed Ratio.
This is the simplest way in which a trader can manage their money. This method is very intuitive and is best recommended for beginners who are still learning all the other topics of forex trading.
How fixed lot money management works is that you as the trader, decide that you will risk a certain monetary amount every trade no matter what.
- Very Intuitive and easy to implement – therefore you know if you traded 10 times and you risk only $5 per trade, you could lose/make maximum of $50, so you can get a quick overview of you money management without any need to calculate anything.
- You miss out on greater returns when your account grows and you risk too much during a period of drawdown – Let’s say you risk/make $20 per trade on a $1000 dollar account meaning a 1:1 risk reward ratio. This means that at $1000 you can gain or lose 2% per trade. You then through a green patch of winning 10 trades in a row giving you a profit of $200. Now your account is $1200 but you are only making $20 which is now only 1.6% of your total account. Hence you are not making as much as you could be making.
- The same works for a losing streak. If you lose 10 trades in a row – you would lose $200 meaning that your account would end up being $800. If you use fixed lot and risk $20 then you would now be risking 2.5% of your account. Which is now more than the original risk when your account was at $1000.
Therefore fixed lot money management is a double edged sword. The fixed percentage money management technique is used to combat this pitfall.
Fixed Percentage Money management
This form of money management is the most common form of money management.
The premise of fixed percentage money management is that you risk a percentage of your money per trade instead of a fixed amount. The table below shows the difference in capital between fixed lot and fixed percentage
- Because you risk a percentage, in theory you could never blow your account
- The principle that if you lose 50% of your trading capital, you would need to make 100% due to the lower percentage increase, therefore it is harder to grow your account with fixed percentage money management if you do not have a win ratio that can mitigate this negative, or if your trading strategy experiences periods of consecutive losses.