Money management: the rules of effective money management, worth a lot of money
Money Management (MM) - is a complex of measures, which implies multiplication of investments and other investments. Money management is an effective capital management, which minimizes risks when trading on the foreign exchange market.
Without following MM rules any trading is doomed to failure sooner or later. Unfortunately, violation of the rules of effective money management is the most common mistake of beginner traders, which leads to unfortunate results.
Of course, it's up to trader's personal choice to follow MM rules or not. Almost all traders know examples of how a position opened with the whole deposit has brought fabulous profit by increasing the initial deposit several times. It is possible. Several times. After that, a tangible loss will inevitably follow, sometimes even "for the whole deposit".
Let's take a closer look at the basic rules manimangement on .
Effective money management - how to calculate the level of risk on Money Management
As a rule, the size of the recommended risk when making a transaction on the 2-5% of the deposit. What does it mean? It means that trader sets stop loss order so that, in the case of failure, the monetary loss does not exceed 2-5 % of his available deposit. Accordingly, in order to lose the deposit completely, a trader will need to make a continuous series of 50 (risk 2%) or 20 (risk 5%) transactions.
If you do not adhere to the rules of effective money management, and open a position with a size "from the heart", hoping for quick and impressive earnings, the deposit is enough for a couple of losing trades, and the probability of a continuous series of three transactions is much higher than the probability of a series of twenty.
In order to correctly calculate your trading risks, you must be able to calculate the optimal volume of your deal. Here is an example.
The trader has a deposit of $3,000 and decides that the optimal level of risk for him is 2%. That is, the trader's planned loss on one trade should not exceed 3000 x 0.02 = 60 dollars.
Making a trading plan, the trader plans to sell Brent oil when the price rebounds from the resistance line downtrend:
- the entry point is 99.20;
- stop loss above the nearest local high at 99.65;
- Take Profit at the downtrend support line at 97.20.
What lot can I enter the trade? Stop Loss is 99.65 - 99.20 = 45 pips.
Accordingly, the risk taken by the trader in 2%, 45 points of stop-loss should not exceed the amount of $60. Accordingly, the value of 1 pip will be 60:45 = $1.33.
Since for Brent crude oil 1 pip in a standard lot is $10, and the required size of 1 pip for us is $1.33, the volume of our position can be represented as a proportion:
1 lot - $10
X lot - $1.33
Accordingly, X (required position volume) = (1.33 x 1)/10 = 0.13 lots.
Why 0.13 and not 0.133 lots? Because. MetaTrader 4 trading terminal allows you to open positions with a volume of up to the second decimal place.
For the convenience of calculating the maximum lot recommended by MM rules, you can make a formula:
Max_Lot=SL% / SL pip / Price, where
- SL% - the level of risk accepted by the trader on one deal, expressed in monetary amount;
- SL pip - the size of the stop loss calculated in the trading plan, expressed in points;
- Price - the price of 1 pip for a trading instrument selected by the trader.
Correct Stop Loss and Take Profit Ratio by Money Management
At the best take profit to stop loss ratio is considered as 3 to 1 or 2 to 1, that is, the planned profit should exceed the planned loss by 2-3 times.
This ratio is not accidental. It is not difficult to calculate that if the tp/sl= 3:1, one profitable trade will cover three losing trades. Nevertheless, many beginners ignore this rule and find themselves in approximately the same situation:
There are two traders trading Brent oil. The price is in a downtrend. Both of them have a clear trading plan where they plan to open a short position when the price rebounds from resistance lines trend.
The first trader opens shorts at point 1 at 102.61, taking a stop loss behind the previous local high at 103.31 and setting a take profit near the downtrend support line at 97.57. The planned profit is 102.61 - 97.57 = 504 pips, the planned loss is 103.31 - 102.61 = 70 pips. The ratio tp/sl = 504/70 = 7:1, which is more than good.
The second trader, having made wrong conclusions from the chart analysis, having listened to other people's "recommendations" or simply "having missed" the entry point, opens a short position in the middle of the trend or, as they say, "right after", at point two at the level of 100.18, with a similar level of stop-loss 103.31 and take profit 97.57. The logic of his reasoning is simple - the trend is descending anyway, so, with a high degree of probability, it will continue. How can we not sell in a downtrend? The stop loss set high does not bother him, because the accurate calculation of the deal is substituted by the hope that the downtrend will continue. Putting a stop loss below the local maximum, already within the trend, does not allow him the rules of trading along the trend, because the probability of getting a stop loss in this case increases many times.
As a result, the second trader gets an open short with a planned profit of 100.18 - 97.57 = 261 points, the planned loss is 103.31 - 100.18 = 313 points. The ratio tp/sl = 261/313 = 0.86/1. That is, the projected profit is even less than the projected loss! No one, even the great Warren Buffet and George Soros do not know where the price will be in a few minutes, and entering in the middle of a trend, the second trader knowingly increases the probability of making a loss, and quite a significant one.
It is worth noting that the first trader's trade given in the example with tp/sl = 7:1 is almost perfect and does not happen as often as we would like. What to do in this case? The correct answer is nothing. Sit and wait. In this case trading is a bit like fishing - a patient fisherman does not run from place to place in search of a good spot, but he is patiently waiting for a nibble and then he is rewarded with several, but big fish. Making just one, but correctly calculated transaction in a week, the trader will make much more profit with minimal risk than the trader who strives to earn as much as possible, opening transactions in violation of Money Management rules and ignoring or not having a trading plan at all.
It would be appropriate here to digress a bit and remind you that trading is not a game, there is no place for gambling. The pursuit of profit in violation of the simplest rules of money management demonstrated by the second trader allows us to draw a simple analogy. The man runs after the bus, which seems to be going in the right direction, jumping on the bus, and then wonders what route it is. Is it any wonder that he ends up going the wrong way?
A large number of open transactions
In principle, no one forbids a trader to have more than one trade on his deposit. Their number may be limited only by the size of trading account. However, a beginner should not get carried away with it; opening several deals at once is the lot of experienced traders who have overcome their emotions and strictly adhere to the rules of their trading system.
For beginners, ForTrader.org recommends that you enter the next trade only after closing the previous trade at stop-loss or take-profit (or, alternatively, after moving stop-loss to Breakeven).
As a rule, a trader, for some reason, after opening deals turned to the profit, assumes that that is the end - the profit will grow, all they have to do is to wait for the deal closing at take profit. Trying to take more profit from the market, the trader opens a deal on one or more currency pairs. However, as we have already mentioned above, the market is unpredictable. There is always a probability that the deal, demonstrating the positive, in some time, often very short time, will go in the negative.
Having loaded the deposit with trades, the trader again consciously increases the likelihood of getting a loss, often paying for it with his trading accountHaving experienced all the "delights" of getting Margin Call.
In conclusion, it should be said that the above rules of Money Management or effective money management are not canonical, but basic principles of money management. Each trader can and even needs to improve them, developing his own rules for his trading tactics, but without their strict observance trading on the currency market will be certainly bright, but, alas, unsuccessful.