The 3 Step Approach To Forex Money Management And Risk Control
It should not be very difficult to create a forex money management and risk control plan. As a matter of fact, it is a simple thing you can do in order to safeguard your trading capital. However, in spite of this reality, it is quite of a challenge to some traders that to a point that they fail to create a proper strategy.
In case you do not have plans to control risks, sooner or later, your online trading account may end up facing a meltdown, a situation which can cost you your entire trading account. Additionally, the best trading strategy ever is likely to fail to generate any profits in the long run in case you fail to put in place a solid money management plan. Here is a 3-step approach which can help control, risks and manage your account.
Step 1: Set you risk tolerance
How much are you able to risk in every trade without the fear of losing the whole amount? This is the most important thing. If you are able to answer this question honestly and combine it with a trading edge, you will be on the right track to generating consistent profits.
One of the most common reasons why many forex traders do not succeed is due to the fact that they risk too much. Traders are usually great at calculating potential profits on any given setup, however, the risks associated with the trade are usually a second thought.
It is not just enough to determine your risk per trade based on a simple fraction, even though it is half of the formula. By indicating that you will only risk a tiny fraction of your account balance is a common thing, yet it is largely an incomplete methodology.
Step 2: Plan your trade and trade your plan
The best forex money management strategy ever will not be of any benefit without a plan for every trade. Just like it is when controlling risk, you don’t need to have a complicated plan. You simply need to put down your exit strategy in writing.
Your exit strategy ought to include clear definition of your stop loss level as well as your profit target. In case you are one of the traders who pyramid, be sure to write down the critical levels at which you intend to scale into the position. A simple note book or word processor will work.
The moment all the levels are well written down, it is of importance that they are not modified under whatever circumstances. Modifying the levels will work against the plan because it will invalidate your plan of attack. It is also likely to expose you to emotional decision making.
The moment you put money on the line, you lose the objectivity required to trade what is happening rather than what you want to talk place. In many ways, the thought of losing money clouds your judgment.
Step 3: Establish a pain threshold
Since you have now set your risk parameters on a basis of every trade, as well as an identified plan of attack for each trade, it is now time to put in place a pain threshold. A pain threshold is basically the point at which you may be of need of an extended break from the market as a result of a string of losses.
For instance, assuming you lose four trades consecutively. In case you are risking 2% of your account balance on every trade, this will result in an 8% loss of tradable equity. This will definitely rattle your nerves. In this regard, you need to put in place a threshold that prevents you from losing so much that it becomes very difficult to recover.
Finally, it is vital to have a plan that you understand and can abide by on a daily basis. You need to keep it simple and easy to understand.
This is a guest contribution by Charles Dearing.