The Importance of Money Management in Forex Trading

The danger of losing money whenever you enter a trade when trading on the FX market is inherent risky. Although most traders are fully aware of this fact, it is curious that so many traders seem to completely disregard or pay very little attention to money management. When you consider that most traders do not have money management plans and frequently ignore the possibility of losing money on any given trade they enter, the fact that most traders lose money in the markets should not come as much of a surprise.

Trading on the financial markets requires careful money management, especially when the market is volatile. It is a defensive idea that supports successful performance and keeps you with enough money to trade tomorrow. Using a prudent money management strategy assures that the trader will be able to trade again no matter what occurs in the markets, where anything can happen at any time. Using a winning trading system alone won’t guarantee success for traders if their money management practices don’t sustain the advantage their system has over the long term.

Money management abilities are what separate long-term winners from losers in trading. You might think of money management as the operational part of trading. The main goal is to manage risk by keeping market exposure within reasonable bounds at all times. This is accomplished by controlling variables like the total number of open positions and the amount of capital risked every trade. In the end, this guarantees that a trader can sustain losses within the parameters of his or her trading system without “running down” the account.

A smooth geometric capital growth requires both good money management and a reliable trading system. The rate and consistency of the account’s growth are influenced by the amount of money you risk on each trade, the precision of the trading system, and the reward ratio parameters (the mathematical expectation of the trading system). Money management systems can also lessen currency swings through diversification (spreading your risk capital over unrelated currency pairs/trading systems), in addition to managing currency fluctuations by establishing a defined percentage of the capital to be risked on each trade.

When your system generates an abnormally high number of winning signals in a row, your forex trading system and solid money management will shield you from greed and pride (which always demand that you overtrade). As long as you only risk a small portion of your equity per trade, as determined by your money management strategy, no run of losses can completely deplete your trading account. This will also shield you from trader paralysis (inability to open new positions) when your system experiences a losing streak.