Forex Money Management

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5. A practical example of applying money management rules:

Risking no more than 2-3% of the total account per trade... How does it work in practice?
Let's use an example to understand it.

We have opened a trading account of $1000 USD with a broker and got 20:1 leverage. So, now we have leveraged ourselves to $20 000 USD to begin trading with.

More money means a higher trading power. Correct. But, the higher the trading power, the higher the risks; and when we talk about risks we talk about a real account value which will decrease with every loss sustained during trading.
So, when we say risking no more than 2-3% of a total account value we mean the real account value — which is $1000 USD in our case.

Now, let's start trading and do the math.
Let's say, we have decided to risk 2% of the account in each trade.
$1000 x 2% = $20 USD.
This means that when the price goes against us, we will need to be out of the trade once we are $20 dollars down.

Ok, time to trade. Our trading power measures $20 000 USD (thanks to our leverage).

What will happen if we try to trade them all at once: for one $20 000 dollar trading lot order our Forex broker gives us a pip value of $2 dollars. This means that with each pip gained we will have +$2 USD in our pocket. But this also means that with each pip lost our real account will shrink by $2 dollars.
Since we can afford to lose only $20 dollars in one trade, we'll exiting a trade once the market makes... -10 pips! Yes, only 10 pips is required this time to reach our 2% limit.
10 pips * $2 USD per 1 pip = $20 dollars, which is our 2% account limit according with the money management rule we've chosen to follow.

Now, let's try to trade a $10 000 dollar position. The pip value for this position size will be $1 USD.
The math goes as follows:
we can stay in trade until market makes -20 pips against us. Yes, this time we can sustain a bigger market shift.

If we decrease our trading lot to $5000 USD, our sustainability will raise to -40 pips against our trade. (The pip value for $5000 dollar lot will be $0.50 cents).
And so on.

As you can see, with the money management rule in place our real account is under control. And even if leverage allows trading larger positions, the risks should be always under control.

To your trading success!
Jeff Boyd

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