Best money management trading strategies for forex traders

Money management is often an overlooked aspect of the trading process. This is because most traders are focused on the what and when of trading.

Most traders want to know what currency pair to trade?.. what commodity to buy?.. when will the market move?..

There is no question that knowing the what and when of trading is important. But knowing how to allocate the funds to each trade is critically important too. 

For many traders, not implementing a trading strategy with steps on how to allocate your capital to each trade can spell the difference between success and failure. That’s why it is so crucial to learn proper money management strategies that can boost trading performance.

In his book ‘Technical Analysis of the Financial Markets’, author and technical analyst John Murphy talked about his transition from a research analyst to managing clients’ money and how he realised the importance of money management.

"I was amazed at the impact such things as the size of the account, allocation of funds, and the amount of money committed to each trade could have on the final results”.

John Murphy understands just like most traders do, how necessary money management strategies are when creating a trading plan.

What is money management in trading?

Money management is a critical tactic that all traders must employ in order to preserve their capital. By managing their risk and trading size appropriately, traders can ensure that they are able to stay in the market for the long haul and capitalise on profitable trading opportunities.

The objective of money management for traders is to limit their risk while aiming to achieve as much growth as possible in their trading account by increasing or decreasing their position size.

Another important aspect of money management for traders is risk control. By setting stop losses and limiting their exposure, traders can protect their capital from large losses in short periods of time. Additionally, by scaling into trades and only risking a small percentage of their account on any given trade, traders can ensure that they don't lose too much money if their trade goes against them.

3 money management techniques for traders

1. Allocation of funds

There’s no question that there are almost unlimited trading opportunities in the markets. 

Whether traders are interested in forex, stocks, indices, commodities, or crypto the chances are they can find a trading opportunity that will suit their trading style.

However, there is one thing that can stand in the way of taking advantage of these trading opportunities.

Trading capital.

For many traders, starting with little trading capital is the only way to get into the markets. So, when considering the almost unlimited trading opportunities and the limited trading capital, obviously something has to give. 

This means traders need to have a system of allocating trading capital to each market they want to trade. In most cases, this may mean trading only in one or two markets at the most, even if there are many other markets to explore.

Allocation of funds is usually done on a high level – which means deciding which market a trader will trade in. Do they choose forex or commodities? And do they have enough capital to trade both of those markets?

While traders definitely need to decide what to trade, they also need to have a system on how much funds to allocate for each market being traded.

How to apply allocation of funds in trading?

Let’s say a trader has $10,000 in trading capital. This may be too little if they want to trade every market financial market.

This is when to be selective. Traders need to make a decision on which markets to trade.

After analysing the different markets, the trader decided to trade both forex and commodities. By doing this they have narrowed down the markets and then can allocate $5,000 for each market with a 50/50 split of their trading capital.

2. Position sizing

Position sizing brings your allocation of funds to another level. 

At their core, position sizing techniques involve deciding how much to allocate per trade and how much risk to take per trade.

For example, a trader wants to trade EUR/USD, USD/JPY, and USD/CAD. Depending on the size of their trading capital and previous experience trading these forex pairs, the trader may want to allocate different amounts to each trade.

Linda Raschke, a well-known commodities trader, said in an interview that her preferred way of position sizing is to use a standard lot or contract size per trade. This gives her a certain level of control and limits her exposure per trade.

If the trader decides to trade the 3 different FX pairs, they may open 1 mini contract per pair. And depending on the price movement of each pair, they can either cut the losses or ride the winners.

Position sizing is important as traders can pre-set how much money they want to put into a specific trade.

How to apply position sizing?

Following the example above, the trader can use position sizing by allocating a certain amount per trade from the two lots of $5,000 they decided to use trading forex and commodity markets.

For example, the trader can allocate say $1,000 to a EUR/USD trade, another $1,000 to a USD/JPY trade, and another $1,000 to the USD/CAD trade.

For the commodities trades, they can do the same and allocate $1,000 to trade WTI Oil, another $1,000 to trade gold and another $1,000 to trade silver.

Please keep in mind that these examples don’t take into consideration the margin level you will use on your trades. We have used dollar values only to simplify the examples.

3. Use of stop-loss

Using stop-loss orders is the third component of a successful money management trading strategy.

When using a stop-loss order, traders draw a line in the sand and limit the number of losses they want to be exposed to.

Most trading platforms now have built-in stop-loss levels that can be adjusted to suit different trading styles and risk management levels.

The other important benefit of using a stop-loss order is that traders don’t have to sit and wait in front of a computer to monitor the price movements. When setting up your preferred stop loss level, most trading platforms will execute it once the level is hit. 

TIP: A stop loss is an order to sell an asset when it reaches a certain price and is designed to help limit a trader's loss on a position. It helps to have some protection in place in case the market moves against them and they are unable to exit the position themselves.

Now that we’ve discussed some of the best money management strategies for traders, let’s understand the dangers you could face by not implementing a money management plan.

7 dangers of not utilising money management in trading

One of the most important skills in poker is knowing how much to place on each hand and to press when the odds are in your favour.

And so too with professional traders, need to build a strategic money management plan that allows them to cut positions when it isn’t working and maximise opportunities when they are winning.

The old maxim rings loud and true when it comes to trading in that you must ‘Cut your losses and let your profits run'.

Let’s review some of the dangers of not having a money management plan in place and what it will mean for bottom-line results.

1. Losing all your hard-earned trading capital

The truth is, when it comes to trading, traders can lose more than what they start with. Once the losses get too big, they are out of the game. Capital preservation is critical for traders to stay in the game.

2. Being clueless about how much needs to be risked in each position taken

Traders must know how much is appropriate to risk based on their account size and the volatility of the instruments being traded. They cannot just trade the same dollar amount or random dollar amounts and expect a smooth, rising equity curve.

3. Believing that one trade will ‘finally set you free’

We hear this time and time again. ‘All I need is one amazing trade, and I can finally say goodbye to my dead-end job’. This is not how trading works. Traders must steer clear of this mindset and instead build up consistency and learn how to apply their edge across the markets in a consistent, steady fashion.

4. Averaging down into losing trades

This will always be the eventual death of a trading account. It might not happen this year or next year. But if traders average down enough and do it aggressively, they will wipe out. Do not average down.

Averaging down is also referred to as a martingale position sizing strategy where traders increase the size of their position as they are losing. This is the opposite of professional trading. Professional traders employ anti-martingale position sizing strategies.

5. Not knowing how to add to winning trades

The guiding principle of trading is to cut losses short and let profits run. In addition to letting profits run, traders must explore the option of adding to winning positions. This is dependent on the type of system they have with trend-following systems being able to take advantage of this principle the most.

6. Revenge trading is part of your toolkit

Emotionally driven trades are a huge danger zone if you want a healthy trading account. Traders must do everything they can to eliminate any form of revenge trading. Treat each trade as independent of the previous one with a new expectancy and the ability to focus on the quality execution of a trading plan.

7. Knowing when to cut back when on a losing streak

Another big danger zone for traders is combining revenge trading with a losing streak. The amateur trader will get their blood pumping and think in terms of ‘How big does my next position need to be to win back all my previous losses and then some?’.

Instead, a professional trader will stop trading or halve their position size until the numbers of their system match their backtesting results.

Another big danger zone for traders is combining revenge trading with a losing streak. The amateur trader will get their blood pumping and think in terms of ‘How big does my next position need to be to win back all my previous losses and then some?’.

Instead, a professional trader will stop trading or halve their position size until the numbers of their system match their backtesting results.

Important to implement proper risk management strategies

Implementing risk management strategies into a trading plan can make the difference between gambling and real trading. When trades are placed without consideration of risk, this is when a trader can start losing money.

Trading is all about taking calculated risks - traders are trying to minimise losses while maximising their profits.

Remember these risk management tips when creating your money management strategy:

• Set take profit price using risk reward ratio
• Keep your emotions out of your trading decisions
• Calculate your expected return

Money management tips

It doesn't matter whether you are a scalper, swing, or day trader, money management rules are a critical aspect that all traders need to learn and implement in every trade they open.

• Traders should never invest more money than they can't afford to lose
• Always remember to set stop loss and take profit orders
• Don't overreach when the target profit is hit, close the trade and enjoy the gains
• If you are a new trader, don't trade more than 2% of your trading capital on a single trade
• Accept the risks that come with trading - nobody likes to lose money but traders must understand that it is a part of the journey

Money management in trading books

See our list of the best money management books for trading to continue learning about money management and the best ways to preserve capital.

• A Trader's Money Management System - Bennett A. McDowell
• Definitive Guide to Position Sizing Strategies - Van Tharp
• Profitability and Systematic Trading: A Quantitative Approach to Profitability, Risk, and Money Management - Michael M. Harris
• Profit Strategies: Unlocking Trading Performance with Money Management - David C. Stendahl

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This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation, or needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability regarding the accuracy and completeness of the content in this publication. Readers should seek their own advice.