Before you start trading it is vital that you take the time to study the currency markets and that you start your Forex trading with a clear philosophy and a defined strategy. Once you start trading however it is equally important that you manage the funds available for trading with care.
As well as knowing which currencies to trade and being able to recognize entry and exit signals for trading, the successful Forex trader must be able to manage his resources and to incorporate money management into his trading plan.
There are a number of different strategies that can be applied to money management, but most of them will be based upon keeping a track of your core equity. Your core equity is the sum that you start trading with less the money that you have in any open positions. So, if you start trading with $10,000 and have $1000 in open positions then your core equity is $9000.
As a general rule, when starting out you should try to limit your risk to 1% to 3% of each trade. This means that if you are trading a standard Forex lot of $100,000 you should limit your risk to $1,000 to $3,000 and, for safety, should probably start at just $1,000. This can be achieved by placing a stop loss order 100 pips (where 1 pip = $10) above or below your entry position for a trade.
Over time your core equity will rise or fall and you can then adjust the dollar amount of your risk. Taking our example above, with a starting balance of $10,000 and one open position, your core equity is $9,000. If you then add a second open position, your core equity will drop to $8,000 and you should limit your risk to $900. Similarly, your risk in a third position should be limited to $800 and so on.
Using the same principal, as your core equity rises, you can also increase your level of risk. So, if trading is going well and you have made a profit of $5,000 your core equity is now $15,000 and you could raise your risk to $1,500 per transaction. As an alternative, you might also decide to risk more from any profit made than you are prepared to risk from your original starting capital. You might, for example, decide to risk up to 5% of any realized profits ($5,000 on a $100,000 lot) to give yourself a greater potential for profit.
The secret to success in Forex trading relies on many different factors and one extremely important element of your trading strategy lies in your ability to tightly control and manage the money that you have available for trading.
By David Shephard
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