This has always been an extensive and comprehensive topic in our industry with numerous writtings yet only very few still understands. But as you might have observed, we love going straight to the point of action, keeping things cool and simple. Hence this topic won’t be any different.
At the end of this article you would have understood vividly:
- The meaning of Money Management
- How it can affect your trading success
- How to properly calculate and integrate money management in your every trade
- The benefits of proper money management in trading.
What Is Money Mangement?
Money Management is a critical element of trading the financial markets whereby a fraction of the account/trading capital is exposed to the market. This methodology can be well described as a defensive measure to ensure proper protection of the whole trading capital from any market eventualities that could be too risky.
Keeping It Simple(Let’s Do The Maths)
If you have a trading capital e.g. $5000 and decides to expose only 2% of this capital to the market on every trade, then we can well say that you’re applying 2% money management rule per trade
Therefore your trading risk per trade will be
Account Capital * 2% = $5000 * 2%
Trading Risk =$100
You can observe now that for every trade you will only be exposing $100 instead of $5000, hence your trading risk is $100 while your trading capital is $5000.
How To Apply Money Management To A Trade
Now you have known what’s money management, trading risk and trading capital. You have also understood how we derived the trading risk sum from trading capital, now lets open a trade.
Before opening a trade, you must identify and set where to place your entry, stop loss and take profit orders(this is very important).
Opening A Trade
1st Calculate your stop loss distance
(Sell Order) Stop Loss Distance = Stop Loss Price – Entry Price
(Buy Order) Stop Loss Distance = Entry Price – Stop loss Price
Now we’ve know our stop loss distance, let’s find our lot size
Lot Size = Trading Risk/Stop Loss Distance * 10
You now understand how to properly calculate your trades, now lets go trading.
Now Let Us Trade
Micheal has $1000 trading capital in his live account, finds opportunity to buy EUR/USD 1.13505 with stop loss at 1.13005 and take profit at 1.14505. What will be his lot size if he is applying 2% money management rule?
1st We calculate his trading risk
Trading Risk = $1000 * 2%
Now his stop loss distance
= 1.13505 – 1.13005 (Buy Order)
Stop Loss Distance = 50pips
Therefore Micheal’s lot size for this trade
= $20/50pips * 10
= 0.04 lots
So Micheal’s position/lot size in this trade is 0.04lots
Benefits Of Money Management
There are several benefits money management can accord a trader. In my opinion, no trader, investor nor fund manager should undermine the impending risks to their trading capital if they ever fail to apply money management rule to their trading. Some major benefits of proper money management rule include:
- Keeping your account in good health no matter how bad the market might go against you.
- It’s a proponent part of proper account management that ensures you last longer as a trader in the volatile Forex market
- Keeps you save on the downside of you trading, thereby preventing excessive drawdowns
- I can as well say its an aspect of trading that ensures a successful trading career.
If you find this article helpful or might want to contribute, kindly drop us a comment below