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Forex Money Management

Learn to control risks in trade. Forex smart money management



 
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2. Returning the lost capital is harder that it seems to


Let's take a look at calculations where a trader has lost some part of his account. How much effort will it take to recover the original account balance?

Account % of account lost New balance Need to make
$ 5000 25% $ 3750 35% of the new balance ($ 1250) to cover losses
$ 5000 50% $ 2500 100% of the new balance ($ 2500) to cover losses
$ 5000 75% $ 1250 300% of the new balance ($ 3750) to cover losses
Note that it's only about covering losses: Who is going to make money then..? And when..?

Now, here is a challenge: try on your demo account to gain a return of 300% or at least 100% of your original account trading as it were the real money. Will that be easy? I don't think so. Can you prove me wrong?

3. Calculate risk / reward ratio before entering a trade

When chances to win in a trade are smaller than potential losses, don't trade! Remember — staying aside is a position.

For example:
losing 40 pips versus winning 30 pips,
losing 20 pips versus winning 20 pips,

both examples are showing a bad risk management.

Before entering a trade, reassure that risk / reward ratio is at least 1:2 (but ideally 1:3 or higher), which means that chances to lose are tree times less than promises to win. For example: 30 pips of a possible loss versus 100 pips of a potential win is a good trade to consider taking.

Adopting this money management rule as a must, in the long run it will dramatically increase your chances to succeed in making stable profits.

Next chart shows the risk / reward rule in practice.

10 trades with 1:3 risk / reward ratio were conducted.
A trader was losing only $100 in a trade when he was wrong, but was winning $300 in each profitable trade.

Trades Losing trades Winning trades
1   +300
2 -100  
3 -100  
4   +300
5   +300
6 -100  
7   +300
8   +300
9 -100  
10 -100  
Total - $500 + $1500
Grand Total + $1000 in profit

As we can see, using 1:3 risk / reward ratio constantly and being successful only 50% of the time, anyone can make a profit in the end. The higher the reward ratio (compared to the risk ratio) the better are chances to end up in profit.

4. Learn to use protective stops

Continue reading about protective stops and their importance for good money management: Learn to use Stop Loss effectively


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