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5 Must-Read Tips for Forex Traders
11/25/2014 6:00 am EST
Nial Fuller of Learn To Trade The Market highlights five money management tips every currency trader should follow if they want to be in this business long term and make money consistently.
Managing your money properly as you trade the forex market is the key to maintaining the proper trading mindset and to becoming a consistently profitable forex trader.
Many traders-mostly beginners-do not manage their risk effectively for a number of reasons. Usually the main reason is that they choose to ignore the risk associated with trading the markets. Let's be honest here: forex trading is inherently risky, and you can lose money on any trade you take.
It's a well-known fact that most traders lose money in the markets over the long run, and perhaps a lesser-known fact is that most traders don't properly manage their money in the markets.
There is more than a correlation between improper money management and failure as a forex trader; in fact, improperly managing one's money is usually the reason for the failure. Here are some concrete tips that you can begin implementing immediately to get your forex money-management plan on track:
Only Trade with Money You Don't Need
Perhaps the easiest thing you can do to get started on the right path to successful forex trading is to make sure you only risk money in the markets that you absolutely do not need for anything else. I like to refer to this as "fun money," or entertainment money.
If you have any money left over after all your monthly expenses are taken care of, you can consider this fun money that you can use to trade the markets. This is especially important when first beginning since your trading skills will not be as sharp as they will be after a few years in the markets.
The ironic thing is that most beginning traders trade money they should not be trading with, and it's only after a lot of losses that they finally realize they should take a break or wait until they have truly disposable income, or fun money, to trade with.
When you trade with money you really don't need for anything else, it will significantly decrease your emotional attachment to each trade, which will, in turn, significantly increase your chances of profiting consistently in the markets.
Master Your Trading Strategy on a Demo Account First
One BIG mistake that most beginning traders make is that they jump face first into the markets without first trying their skills on a demo account. While demo trading is devoid of the emotion of real-money trading, it does give you the ability to work out the "kinks" in your trading strategy before you start risking real money.
It also gives you time to familiarize yourself with your broker's trading platform. These two things alone can save you a lot of money by allowing you to avoid making stupid mistakes that many newbie traders make. I suggest all my students see three months or more of consistent demo account success before risking their hard-earned money in the markets.
See related: Are You Ready to Trade Real Money?
Focus on Containing and Limiting Risk First
You should think of yourself as a risk manager more than a trader. I find that beginning traders focus far more on the potential reward of a trade than they do on its potential risk. In reality, if you are more focused on limiting your risk per trade to an amount that you are comfortable losing, the rewards will tend to take care of themselves.
See related: The #1 Priority Before Any Trade
Obviously, you'll need to put some time and effort into developing an effective exit strategy for your forex trades, but the point is that you should be more concerned with risk than reward. Think of it like this: if you do not properly contain your risk and let it get out of control, you are going to get stuck in a constant cycle of trying to "make back" what you just lost and get back to breakeven. This is what most traders end up doing. Be different.
Be Sure You Understand Risk/Reward Ratios and Position Sizing
Next, two big errors that most traders make at some point-usually in the early going-is not fully understanding risk reward and position sizing in forex trading.
I teach my members to track their trading performance in terms of dollars risked vs. dollars gained; not by pips or percentages. The reason why I do this is because pips and percentages are essentially irrelevant. If you contact any big hedge fund trader or any other professional traders, they are going to agree that what matters at the end of the year is what return you got for the dollars you risked; not how many pips you made or what percentage of your account you risked.
Through position sizing, you can trade a big position size on a small account (not recommended) or smaller position size on a bigger account. Therefore, while two traders might make the same amount of pips on the same trade, they could make (or lose) drastically different dollar amounts relative to the dollars they risked. Thus, the proper way to gauge risk and reward is via how many dollars you gained overall vs. how many dollars you lost overall.
See related: Make Sure Risk/Reward Is on Your Side
Take Logical Profits When the Market Gives Them
Finally, another big mistake that many beginning and experienced traders make is that they simply don't take profits when they should.
Now, profit taking is probably the most difficult part of trading, and there really is no "right" or "wrong" way to do it. But, generally speaking, we want to make sure our winners outpace losers by a factor of two-to-one or more.
When you make a risk reward of 1:2, you can actually lose on about 33.3% of your trades and still break even. Thus, if you can hit around a 40% win rate (losing 60% of the time!), you can still make money over the long run!
For this reason, I typically take a 1:2 profit on a trade when it presents itself, rather than holding out in hope for the big winner that rarely comes. If I think a market has more room to move and it's trending well, I might move my stop to breakeven, but I will lock in my two times risk/reward as soon as possible, as my main goal is to secure that profit and not let it get away like so many other traders do.
By Nial Fuller, CEO and founder, Learn To Trade The Market
Nial Fuller is CEO and founder of the Web's foremost trading education community, Learn To Trade The Market, a global leader in forex trading education and training. The Learn To Trade The Market Forex Price Action Trading community has become a vital education resource for aspiring forex traders.
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