Money Management Strategies
One of the most important aspects of trading is money management and the successful use of its concepts differentiates experts from beginners.
Money management strategy is a statistical tool that controls the risk exposure and profit potential of each trade entered and its proper deployment provides maximum account protection.
Three strategies are presented here to help traders, especially, beginners, understand the major concepts of money management. Although there are a great many money management systems, they all fall into one of the three categories defined here in one form or another.
All of these strategies assume that you are dealing with a trading system with a positive expectation since this is a minimum requirement for successful trading. For more on this see the sections titled Expectation Value of Your System and Expectation Value Examples.
The Martingale strategy is a category of money management that recommends that the value of every new trade should be continually increased after a loss. This method, which is based on probability theory and made popular in 18th century France, is seriously flawed because it is based on the concept that you cannot lose all of the time.
The Martingale system is commonly compared to betting in a casino where gamblers repeatedly double their bets after losses as they will, in theory, eventually even out with a win.
The Martingale works in the same way when applied to FOREX Trading. Basically, trades are always made in the same direction and after each loss, traders simply double their stake until there is a trade reversal resulting in a win.
The problem with this method is that while it is true that you will not lose all of the time, it is impossible to predict how many losses you will have in a row. If the currency pair keeps moving in the losing direction, without any reversals for some time, you will need very deep pockets in order to continue increasing your position size after each loss and will in all likelihood totally deplete your account.
For example, image you have a balance of $100,000 and are trading safely using just 1 lot worth $1,000. By doubled your lot size after each loss, your entire account balance would be desecrated if you were unfortunate to experienced eight consequent losses.
For this reason alone, the martingale trading strategy is considered far too risky and is not something anyone should consider.
Contrary to the Martingale system, the anti-Martingale accepts greater risks during periods of expansive growth and is more conducive with the FOREX maxim ‘cut your losses short and let your profits run’. As the name implies, it is essentially the exact opposite strategy as the martingale.
However, this method still poses problems as the following example shows.
Consider again that you have a budget of $100,000 and are FOREX trading conservatively using 1 lot worth $1,000. Assume a trading trend produces five consecutive profitable trades for you. Applying the Anti-Martingale strategy, you would have doubled your entry stake after each winning trade which implies that you would have entered the sixth trade risking about 30% of your total balance.
Of course and with time, the Anti-Martingale method could be dove-tailed into a successful trading system, but this process could continuously place your account at considerable and unacceptable risk. Without sufficient care, you could place your long-term survival in serious jeopardy. This is especially the case if you are a FOREX novice.
This Strategy states that traders should never risk more than a fixed amount of their total account on any single FOREX trade and, in fact, 5% or less is generally the recommendation depending on your tolerance for risk. The risk for each trade is kept within these parameters by correctly determining its Position Size and Stop Loss. You can learn how to do that in the section titled Position Size and Risk Per Trade.
Position Size is the amount of currency to be either bought or sold. Stop Loss determines the acceptable loss a trader is prepared to take.
This strategy, combined with the following concept, makes it more amenable for beginners because it enables them to advance their trading knowledge in small increments of risk with maximum account protection. The important concept is ‘do not risk too much of your balance at any one time‘.
For example, there is a big difference between risking 2% and 10% of the total account per trade. Ten trades, risking only 2% of the balance per trade, would lose only 17% of the total account if all were losses. Under the same conditions, 10% risked would result in losses exceeding 60%. Clearly, the first case provides much more account protection resulting in an improved length of survival.
A final concept to appreciate is that the most successful FOREX traders are first skillful survivors and second big earners.
The recommendations in this guide are all based on Fixed Money Strategy. I highly recommend you use this type of money management in your trading as it provides the safes approach to money and risk management.
If you come across other money management articles and discussions elsewhere just keep in mind that they will invariably fall into one of the three categories just described. By understanding the category of money management the article is describing you will be able to immediately decide whether it is a strategy worth investigating or not.
Fixed Money is the safest. Anti-Martingale is the next safest and should only be considered by experienced traders. Martingale should always be avoided by all as it is considered by professionals as a fool’s strategy.
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Money management strategy is a statistical tool that controls the risk exposure and profit potential of each trade entered and its proper deployment provides maximum account protection.
Three strategies are presented here to help traders, especially, beginners, understand the major concepts of money management. Although there are a great many money management systems, they all fall into one of the three categories defined here in one form or another.
All of these strategies assume that you are dealing with a trading system with a positive expectation since this is a minimum requirement for successful trading. For more on this see the sections titled Expectation Value of Your System and Expectation Value Examples.
Martingale Strategy
The Martingale strategy is a category of money management that recommends that the value of every new trade should be continually increased after a loss. This method, which is based on probability theory and made popular in 18th century France, is seriously flawed because it is based on the concept that you cannot lose all of the time.The Martingale system is commonly compared to betting in a casino where gamblers repeatedly double their bets after losses as they will, in theory, eventually even out with a win.
The Martingale works in the same way when applied to FOREX Trading. Basically, trades are always made in the same direction and after each loss, traders simply double their stake until there is a trade reversal resulting in a win.
The problem with this method is that while it is true that you will not lose all of the time, it is impossible to predict how many losses you will have in a row. If the currency pair keeps moving in the losing direction, without any reversals for some time, you will need very deep pockets in order to continue increasing your position size after each loss and will in all likelihood totally deplete your account.
For example, image you have a balance of $100,000 and are trading safely using just 1 lot worth $1,000. By doubled your lot size after each loss, your entire account balance would be desecrated if you were unfortunate to experienced eight consequent losses.
For this reason alone, the martingale trading strategy is considered far too risky and is not something anyone should consider.
Anti-Martingale Strategy
Contrary to the Martingale system, the anti-Martingale accepts greater risks during periods of expansive growth and is more conducive with the FOREX maxim ‘cut your losses short and let your profits run’. As the name implies, it is essentially the exact opposite strategy as the martingale.However, this method still poses problems as the following example shows.
Consider again that you have a budget of $100,000 and are FOREX trading conservatively using 1 lot worth $1,000. Assume a trading trend produces five consecutive profitable trades for you. Applying the Anti-Martingale strategy, you would have doubled your entry stake after each winning trade which implies that you would have entered the sixth trade risking about 30% of your total balance.
Of course and with time, the Anti-Martingale method could be dove-tailed into a successful trading system, but this process could continuously place your account at considerable and unacceptable risk. Without sufficient care, you could place your long-term survival in serious jeopardy. This is especially the case if you are a FOREX novice.
Fixed Money Strategy
This Strategy states that traders should never risk more than a fixed amount of their total account on any single FOREX trade and, in fact, 5% or less is generally the recommendation depending on your tolerance for risk. The risk for each trade is kept within these parameters by correctly determining its Position Size and Stop Loss. You can learn how to do that in the section titled Position Size and Risk Per Trade.Position Size is the amount of currency to be either bought or sold. Stop Loss determines the acceptable loss a trader is prepared to take.
This strategy, combined with the following concept, makes it more amenable for beginners because it enables them to advance their trading knowledge in small increments of risk with maximum account protection. The important concept is ‘do not risk too much of your balance at any one time‘.
For example, there is a big difference between risking 2% and 10% of the total account per trade. Ten trades, risking only 2% of the balance per trade, would lose only 17% of the total account if all were losses. Under the same conditions, 10% risked would result in losses exceeding 60%. Clearly, the first case provides much more account protection resulting in an improved length of survival.
A final concept to appreciate is that the most successful FOREX traders are first skillful survivors and second big earners.
The recommendations in this guide are all based on Fixed Money Strategy. I highly recommend you use this type of money management in your trading as it provides the safes approach to money and risk management.
If you come across other money management articles and discussions elsewhere just keep in mind that they will invariably fall into one of the three categories just described. By understanding the category of money management the article is describing you will be able to immediately decide whether it is a strategy worth investigating or not.
Fixed Money is the safest. Anti-Martingale is the next safest and should only be considered by experienced traders. Martingale should always be avoided by all as it is considered by professionals as a fool’s strategy.
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