The Authority’ on Price Action Trading. Learn forex with practice trades 2016, Nial won the Million Dollar Trader Competition.
This post was written to expose some truths and some myths surrounding the topic of managing your trading capital. Most information out there on money management is completely useless in my opinion and will not work well in professional trading. I will warn you that what you are about to read is likely to be contradictory to what you may have already learned about forex money management and risk control in other places. I can only tell you that what am I about to divulge to you is the way I trade and it is the way many professional forex traders manage capital. Everyone knows that money management is a crucial aspect of successful forex trading. Yet most people don’t spend nearly enough time concentrating on developing or implementing a money management plan. The paradox of this is that until you develop your money management skills and consistently utilize them on every single trade you execute, you will never be a consistently profitable trader.
I want to give you a professional perspective on money management and dispel some common myths floating around the trading world regarding the concept of money management. Myth 1: Traders should focus on pips. You may have heard that you should concentrate on pips gained or lost instead of dollars gained or lost. The rationale behind this money management myth is that if you concentrate on pips instead of dollar you will somehow not become emotional about your trading because you will not be thinking about your trading account in monetary terms but rather as game of points. If this doesn’t sound ridiculous to you, it should.
This is one of the more common money management myths that you are likely to have heard. Which is not always the best course of action. There’s psychological evidence that suggests it’s human nature to become more risk averse after a series of losing trades and less risk averse after a series of winning trades, but that doesn’t mean the risk of any one trade becomes more or less simply because you lost or won on your previous trade. But once they begin to hit a string of losers, they realize that all of their gains have been wiped out and it is going to take them quite a long time just to make back the money they have lost.
The Most important fact is this. Many traders erroneously believe that if they put a wider stop loss on their trade they will necessarily increase their risk. Similarly, many traders believe that by using a smaller stop loss they will necessarily decrease the risk on the trade. Traders that are holding these false beliefs are doing so because they do not understand the concept of Forex position sizing. Position sizing is the concept of adjusting your position size or the number of lots you are trading, to meet your desired stop loss placement and risk size. Now let’s you want to trade a pin bar forex strategy but the tail is exceptionally long but you would still like to place your stop above the high of the tail even though it will mean you have a 200 pip stop loss. Let’s now look at an example of what can happen if you don’t practice position sizing effectively by failing to decrease the number of lots you are trading while increasing stop loss distance.