Tue. Oct 20th, 2020
money management for forex

Forex Money Management Strategies – Smart Ways To Profit Consistently

Aside from steady emotions, what makes a trader profitable? The answer is good money management skills. But not a lot of traders pay attention to it because it can be a fussy process. Nevertheless, it’s crucial to understand it to make money consistently. This article will cover two common forex money management strategies: risk per trade and reward to risk ratio.

The first part of this article talks about the common terms in money management, and if you’re already familiar with these, you can skip ahead to the money management strategies section.

Money Management Terms


What is Stop-loss?

Stop-loss is an order you place on your trading platform to automatically stop your trade from incurring a larger loss.  

stop loss

However, a stop-loss isn’t just for ending losing trades exclusively.  

You can also use it for trades that are on the profit side to lock in the gains once the trade goes against you, and that’s called a Trailing Stop-Loss.

What is Take Profit?

A take profit order works the same way as a stop-loss, but the only difference is the take profit terminates your trade from gaining more profits. 

Now you may wonder why anyone would want to stop profitable trades, and the answer is take profit orders are best for trades with a predefined target.

take profit

Some traders understand that the market rarely goes in one direction uninterruptedly. There will be periods when buyers take a break from buying, and sellers pause from selling, allowing the prevailing price direction to slightly falter.

Take profit orders capitalize on that market observation and bets on the probability that locking in profits at a certain level is better than seeing a trade conclude with either a loss or a less significant gain.

What is Breakeven in Forex?

Breakeven is one of the common trading terms you’ll hear, and it only means that a trade ended with neither loss nor profit.

A trade that reaches breakeven could be a result of a stop-loss that is moved to the opening price.

What is Risk Per Trade?

Risk per trade is the percentage of your account’s equity that will be exposed to the market.

For example, your account is $10,000, and your risk per trade is 1%. This means that you’ll only risk $100 for every trade.

Again, a stop-loss can be utilized to set the risk per trade.

What is the Reward-to-Risk Ratio?

Simply put, the reward-to-risk ratio tells you what you’ll be gaining relevant to the risk you’ll take. You can set this by using take profit and stop-loss orders. Or, you can close your trade based on what you see on the chart.

It is important that you understand what reward-to-risk ratio is and the risk per trade as these will be the main components for devising a money management strategy.

Money Management Strategies


Now, once you’re familiar with the terms, you’ll be able to understand these common money management rules.

1% to 2% Risk Per Trade

A safe percentage of your capital that you can risk per trade is between 1% to 2%. With a 1% risk per trade, it would take a long time before you get knocked out of the market.

Assuming that you get 100 losing trades consecutively — if that’s even likely — you’ll still have 37% of your capital with a 1% risk per trade.

On the other hand, if you risk 15% per trade, for example, you’ll be down to 5% of your total capital after only 20 trades.

Target a higher reward

Aside from understanding how much you’ll risk per trade, you need to set your eyes on how much profits you’ll be targeting — and, it has to make sense mathematically.

There are two ways to be profitable:

  1. A strategy with a 1:1 reward to risk ratio but with a high win rate
  2. A strategy with a decent win rate but with a higher reward profit target relative to risk

So, the strategy with an even reward to risk ratio will only be profitable if you win more times than you lose. 

And, the strategy with a decent win rate can lose more often than win and still be profitable if the profit target is at least twice the risk.

Check the table below:

reward-to-risk-ratio-sequence-1

This is the strategy with a reward to risk ratio of 1:1 and in 10 trades with equal wins and losses, no matter the sequence of the +1% gain and the -1%, the result after the 10th trade is always the same — $9995.00 or a -0.05% loss.

However, if the trade wins 70% of the time with a 1:2 reward to risk ratio, the account becomes profitable after 10 trades despite taking in twice the risk.

70-percent-strategy

Finally, a strategy that doesn’t have a high win rate but has at least a 2:1 reward to risk ratio can still be profitable. The image below shows a strategy with a 40% win rate with a 2% gain for each winning trade, and the result is a 1.91% gain after 10 trades.

40-percent-strategy

And, of course, some strategies may work 20% to 30% of the time, but if it targets a reward five times the risk, then it would still make a profit. One example of that is the MACD crossover strategy.

Making use of the stop-loss to manage risk

The essence of a stop-loss is to set your risk automatically so that no matter what happens, you don’t incur a loss higher than your intended risk per trade.

Stop-loss can be preset orders, or it can be dictated purely by technicals. If you just started trading, it’s best to set stop-loss orders rather than pick a spot in the chart where you’ll close a trade.  

When you haven’t mastered how your strategy works, your emotions may take over, and you’ll be less inclined to accept a losing trade.

https://www.youtube.com/watch?v=8kCjoOdj1bE

How to set risk with stop-loss

Here are the steps for you to set risk using stop-loss:

  1. Determine the number of pips you’d risk losing from your trade entry.
  2. Determine what your risk per trade will be.
  3. Multiply your account balance to the risk per trade and divide it to the number of pips, and you’ll get the per pip value.
  4. Lastly, divide the per pip value to 0.0001 (if it’s not a YEN pair), and you’d get the lot size needed.

Example: You have a $10,000 account with a 1% risk per trade and 50 pip risk.

  • $10,000 x 0.01 = $10
  • $10 ÷ 50 pips = $0.2 per pip value
  • $0.2 ÷ 0.0001 = 2000 units or 2 micro lots

So, in this example, once your trade goes 50 pips against you, you’ll only risk $10 from your account. 

Do you want to know how you can convert the pips gained in USD to another currency? Read this article.

Summary


To recap, you’ve learned five terms that are necessary for money management: stop-loss, take profit, breakeven, risk per trade, and reward to risk ratio.

You’ve discovered why it’s necessary to have a profit target that is higher than your risk.

You also read two concepts to profit from trading forex.

And, lastly, you’ve learned how you can use the stop-loss to set your risk.

12 thoughts on “Forex Money Management Strategies – Smart Ways To Profit Consistently

  1. For anyone to profit from forex, there is need to be very much more committed to learning how to manage risk as this is the single problem that most traders commit. They often get involved in their emotion and as such, they get clouded by their emotions without following their strategies. All these you have shared here would really ensure that we maintain our risks and always have the odds around us before embarking on any trade.

  2. This is somethiu have been looking to learn for a while now because  I was just introduced to forex trading but I do not know so much about it yet so I was told to learn some terms from it. Now that I have done that, I think what I need necg is some good training. Doyou have any  suggestions on that?

    1. The best training for you Henderson is to try trading on a demo account and master it for at least six months.  During that learning period, try to keep a journal of your trades and develop a trading system that works well for you.

  3. Great, simple and starter friendly article on forex money management baselines I would say. I have been investing in the stock market and cryptocurrencies but also for low-risk low-profit funds past 8 years and I have been cornered to try some forex trading in near future, this really helped me to realize the basics pretty easily. I bookmarked this for further use, your site looks to have a pretty great look on trading generally.

  4. I’ve been slowly weaning my way into forex trading after being a tech stock investor – it is exciting, but there’s also a lot to learn when compared with low leverage stock trading. 

    This money management angle that you’ve published here is going to be a great help to me, as I feel it will give me greater control over what I invest in each trade. What are your overall opinions on leverage for a newbie in the foreign exchange market? Do you feel newcomers should stay away from it?

    1. Hi Chris,

      Well, using excessive leverage isn’t a good idea.  It affects your trading psychology and doesn’t give your trade cushion if it goes negatively.  If you’re a newbie, it’s better to get familiar with all the concepts and at least master trading without risking real money.

  5. I have to say a big thank you for this post because I have a friend who told me he wants to start learning about forex online befire he can start training. Here you have given some basics and after reading g this, I think that even I too should give forex trading a try. This is very lovely to read. I will share your post immediately now. Thanks a lot.

  6. Truly, good money Management skills is a very important thing a trader should possess to make profit in forex trading. These terms are really essential and useful as they will help you get less or no loss in the cause of trading. I’m not a pro when it comes to forex trading, reading this article will do me great benefits, I’m now conversant with these terms and I’ll be able to know what they mean whenever I see them. I tried setting risk with stop loss ones but wasn’t able to, I guess this I’ll now be able to checking through these steps. Thanks for taking your time to impact knowledge on others, it’s nice.

  7. Winning with forex is just not a matter of knowing the market but knowing and understanding the rudiments of money management and risk managements too would be integral to be successful. The tips you have shared here are really good and I’m going to try out the reward to risk strategy. It seems good to me and also interesting.

  8. I am not a trader but this is the best article I have  come across so far. Your explanation of the trade terms were so simple and easy to understand. I am surprised that there is a stop-loss option and also the ability to lock in the gains. I feel like I can already do this.From your explanation of Take Profit, I would not mind stopping the profits once they roll in even if it is small.I hope to acquire trading skills within this year and this site will be my first stop. Thank you so much for this in depth explanation of terms.

  9. Hi! As a newbie in the trading world I’ve committed this mistake you have pointed out: I have holded on to a trade wishing it turns favorable and make the loss bigger. We newbies, are too concerned about our winning average and not as much on the profitability. These concepts I’ve learnt here reading your post have changed my perspective of how I approach trades. Thank you very much for this very helpful post.

  10. Forex trading is what I’ll regard to as a profession of skills and risks but these risks can be put to the minimum if the assignment of getting familiar with some of these important skills is done and that’s exactly what you’ve made simple and available in this article. Money Management is very important in making profits, these five terms you explained in this article will be of great help. I don’t really know a great deal about forex but I’ve also learned for this and I’ll share it with my friends who trade too. It was nice reading through.

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