How to Build a Proper Money Management System

How to Build a Proper Money Management System

9 December 2017, 05:28
Manutsawee Karnchanapiboon

Forex Money Management System

   Forex trading deals with buying and selling a currency against another one. The aim is to make a profit by identifying the correct market direction.

Finding the correct market direction is not a piece of cake. Traders use both technical and fundamental analysis for this. Moreover, in some cases, notions like astrology and the way stars/planets align and influence people’s behavior are taken into consideration. It may sound crazy, but it’s pure truth.

No matter the forecasting method, one thing should prevail: how to manage a trading account. Traders’ ego and personality influence an account more than the method used to find a trade opportunity.

Hence, risk management is key.

NB: Traders should focus first on how NOT to lose money, and then on how to make some.

   Any money management system must start with building the right expectations. While the Forex market gives the impression of prices going in trends all the time, this is not true.

In fact, the Forex market with its huge five trillion dollars daily volume spends most of the time in consolidation. As such, fake moves happen all the time.

The problem with trading the Forex market comes from the way traders perceive it. They come to the trading arena with false expectations. They underestimate the dangers that markets hide.

This is normal. Because brokers use aggressive advertising techniques telling how easy it  is to make money, people start on the wrong foot.

Statistically, over ninety percent of the retail traders lose their deposit in the first six months. That’s a terrible percentage!

When this happens, the next step is the so-called “revenge trading”. Traders deposit more funds in a desperate move to get back what they lost.

By now, you should know the answer. Margin calls, more money lost… The chart below describes the cycle which the average trader/investor goes through

Use Realistic Risk-Reward Ratios

   A Forex trader should never ever risk more than the reward he expects to gain. While other industries favor this (e.g. binary options industry), for a Forex trader this is something outrageous.

Therefore, the risk-reward ratio must have a bigger reward than the risk. Of course, you may look for 1:10 or 1:30 (i.e. risking one pip to get ten or thirty pips). But, these are not very easily attainable returns. Even if they are attainable, they would be very rare.

Remember that the Forex market spends most of its time in corrective waves?
Stats: To be more exact, over sixty-something percent of the time the market trades in a range.

As such, a realistic risk-reward ratio is anything between 1:2 or 1:2.5. That means, for every pip risked, the expectation is for two pips or two and a half pips gain. For a higher return, I have outlined a chapter in my trading course that walks your through the process of reaching higher returns (if the market shows favorable conditions of course).

What’s important is your P/L to show a positive growth. Don’t look for doubling your account every other month. Instead, look for the account to grow naturally, because of a proper money management system applied correctly. And remember not to risk more than 1-2% of your capital per trade. This is essential if you want to survive in the longer term.

Happy Trading,

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