Forex Capital Management: Why Traders and Investors Shouldn’t Ignore It
According to the Bank for International Settlements (BIS), global currency turnover reached $7.5 trillion per day in April 2022. The US dollar remains the dominant currency and London is the main trading centre. However, Brexit has hit the UK hard and as a result, other forex trading centers are also gaining prominence.
Investors and traders across the forex space are constantly looking for winning strategies to try and profit from market movements. Despite the push, there are still traders who ignore forex money management either on purpose or due to lack of awareness. If you want to know how good your trading knowledge is by taking a trade test can help you take your skills to the next level.
What is forex money management?
Forex money management is simply a process that investors and traders use to manage the financial resources in their trading accounts. The most fundamental principle of forex money management is that traders should take all possible measures to preserve their capital.
According to veteran investor Warren Buffett, traders should be careful to “never lose money.” However, that shouldn’t mean they won’t lose a deal. This means that losses must be within manageable parameters.
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Put a break in losing money on Forex
Trading is a business whose purpose is to make money, not lose money. Despite this, many traders, including experienced forex investors, have lost capital at one point or another. In fact, the disclaimer of most investment firms is that you can lose all your money, including the capital you have invested. With rising inflation and household budgets are tightthe last thing you want is to lose money trading forex.
The question that traders must always wrestle with is how to adjust their strategies to minimize losses and maximize profits. That’s what currency money management is all about. There are rules to help you stay on the straight and narrow.
Forex Money Management Tips to Follow
Here are four money management rules that will help you increase your forex trading success. You can customize them according to your trading strategy.
Size your positions
Every position you enter in currency trading involves risking some resources in your trading account. Top traders and mentors usually advocate for 2% of your trading capital. This means that if you have $10,000 in your account, you only have to risk up to $200 per trade.
Proponents of the anti-martingale money management method usually change their trade sizes based on the latest indicators. For example, in case of profit, the trader doubles the next position size. However, for a loss, the trader halves the size of the next position.
Place the maximum drawdown of the account
In forex money management, the drawdown refers to the difference between the highest trading account value and the account value after the loss. If you had $100,000 in your account and you lost $2,000, the loss is a 2% drawdown.
A larger drawdown can make it harder for you to bounce back from a loss. One of the best ways to establish a drawdown is to backtest a trading strategy. For example, you can test up to 40 of your trades and get an average drawdown. If the average value is 6%, then you can apply that. This means that any trade above 6% will be closed.
Assign a risk reward ratio
As a general rule, your winning trades should be double your losing trades, at least on average. Even if you only win a third of the trades you enter, you can easily break even with this risk/reward ratio.
One thing you should note is that a risk-reward ratio say 1:1 means you have to win more trades to break even than a risk to reward ratio of say 3:1.
Plan your exit using Stop Loss and Take Profit
A stop loss helps a trader minimize their losses and a take profit helps maximize their profits. When the stop-loss limit or take-profit level is triggered, the position is closed.
There are trades that trigger a stop loss level and then unfold to lock in some of the biggest profits. However, the reverse is also true, and so you must learn to stick to your rules and only change where necessary.
Conclusion
Forex capital management is a practice that traders and investors should not ignore. This helps ensure that your trades are not so exposed to losses that wipe out your capital. If you work with rules, you will need to adjust them from time to time as circumstances change to optimize your trades.
