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Forex Money Management


By Forex Commune - Posted on 22 March 2011

It doesn’t matter if you can accurately predict the market or not if you don’t know how to manage your money.

Managing your money is important at the grocery store and the gas station, but it’s even more important for Forex traders. No one is correct all the time, so it’s very important to leverage your cash flow and mitigate risk in order to avoid unnecessary losses.

Perhaps the most important aspect of managing your money is knowing how much of your available liquid capital to use to buy and sell currency pairs. Let’s use an example to illustrate this. You invest half of your money in a single pairing and leverage your liquidity significantly -- which is not advisable -- and the price plummets, losing you all your money. Now you actually need to make an incredible 100 percent return on your next investment just to get back to where you started. On the other hand, if you invest 10 percent of your liquidity and lose that, you’ll only need to earn a return of about 11 percent on your next investment. Conversely, if you risk 80 percent and lose, you’ll then need to find a 500 percent return on your next move just to get back to even. Quite simply, the more you risk, the luckier you’ll need to be to avoid losing it all.

A great way to mitigate some of this risk is utilizing the four major types of stop orders.

The most common stop is the equity stop. All you do is place a sell order at a certain point, generally at about 2 percent under your entry point. In this case you can invest $20,000 and risk only $400. Equity stops can also be used in order to get out once you feel the market has likely crested in addition to avoiding losses. Most traders decide to stay within a 5 percent risk at all times.

Next we have chart stops, and there are thousands of different parameters you can set up to mitigate risk. One very popular type is volatility stops, which are placed in order to automatically sell a pair when becomes overly volatile.

Finally, we have margin stops. This type of stop is actually focused more on your account that on the overall market, unlike the other types of stops previously listed. If you trade with leverage, margin stops are vital. If you choose 90 percent, for example, this means that you’ll be leaving the market the second your capital drops below 90 percent of its initial value.

In Forex, the money management is the only way to actually make any money, so these stops and strategies of limiting risk are essential to any trader, be it the seasoned pro or novice.
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