Having a good grasp of the market dynamics, trading concepts and technicalities will help traders prosper in the market, but there are additional skills that traders need to acquire to remain successful consistently. Everyone knows that a currency trader needs to be analytic, logical, and strategic but another trait that should be there for succeeding in the forex market is discipline.
This is not just about trading discipline but also financial discipline which means efficient money management. If you are not good at managing your own funds and trading capital, you won’t be able to attain long-term profitability as a forex trader.
Hence, you should devote some time to reading about this topic and this article can be a perfect starting point for all forex traders looking for some money management tips. Don’t forget to polish your skills by trading on a demo account first to get more help in understanding the intricacies of trading in a risk-free manner.
What is Money Management in Forex Trading?
To understand the true meaning of money management in forex trading, you need to learn about risk management first. Risk management is aimed at mitigating the risk that you are dealing with during the trading process as the market can move in any direction.
You should be prepared to lose some money but these losses should not exceed the set limit which is based on your risk tolerance. The goal of risk management is to minimise the potential losses by taking calculated risks considering how much you can afford to lose in a single trade.
Money management has a wider scope than risk management as you will not only be looking at the losses but also at the account balance as a whole as the purpose of money management is to preserve the trading capital.
Risk management is a part of money management as you cannot safeguard the trading capital without limiting your risk exposure. The money you use for a trade is at the risk of loss and when you learn to cope with this uncertainty professionally, you get better at trading.
Tips to Manage Your Money Successfully
Start trading on a Demo Account
As stated earlier, a beginner should always trade on a demo account before risking real funds. Demo accounts are like a trading account simulation and replicate real-time market conditions to show the potential results of your trades.
You will be provided with virtual funds for a realistic experience and you will get to learn a lot about market fluctuations and how it impacts your account balance while trading on a demo account. It is usually offered by forex brokers as a practice account for new traders but experienced traders can also utilise a demo account for testing their strategies.
One thing you can do to make the best use of a forex demo account is trading with a serious approach just like how you would trade if it was real money. By doing so, you will be able to understand the concept of risk management and money management from demo trading itself.
This knowledge will help you to follow a cautious approach while going live later on. Demo trading is also useful to understand the features and functionality of various trading platforms like MT4 and MT5 along with the trading environment offered by your broker.
Those who are not familiar with these platforms may make silly mistakes during the trading process and demo account practice is essential to enhance your skills before actual trading. Usually, brokers offer a demo account facility for all the trading platforms that they offer and you will be able to freely trade on these accounts for a month or more based on your broker’s policy.
After the expiry, you can either open a new account or renew it, if you feel like you need some more practice before going live. You can continue to trade the demo as long as you want.
Experts suggest staying on a demo account for a few months before switching to an actual account. Because, the more time you spend on a demo account, the more you get to learn about the forex market and trading processes.
You will be able to try different trading techniques and choose the best ones based on your skill level. Although you won’t be able to feel the emotions that you experience during an actual trading process, demo trading can make you more confident and clear-minded while placing trades with real funds at risk.
Start small and don’t take excess risk
Not all traders come from the same financial background and the risk tolerance will be different for each trader. You might see traders with bigger-sized trading accounts with huge amounts of money as trading capital.
However, not everyone can afford to risk a lot of money in the trading process, especially during the initial phase of one’s trading journey. Because, being a beginner, you are more likely to make mistakes during the trading process while going live for the first time.
Demo account practice is surely helpful to avoid some of these mistakes but it is impossible to learn everything from a demo account as it has some limitations. Demo accounts do offer real-time market conditions but the order execution is very different from a live account as there is no order queuing or price re-quotes happening.
Hence, you won’t be able to prepare for such situations on a demo account and it will take some time to adapt to the constantly fluctuating forex market.
Hence, I will advise you to start trading with a small amount of money based on how much you can afford to risk in the first place. Many beginners end up losing a lot of money as they take huge risks with the expectation of reaping big rewards.
But this will only lead to huge losses when you lack the experience and skills to navigate the volatile currency market. Starting small would be the best approach when you are about to trade for the first time and you should take your time before depositing more.
Even after gaining experience, you should not become overconfident as this is another reason behind many traders risking a lot of money and using too much leverage to increase their profit potential.
You should always use trading tools like Forex calculators before making any trading decision as they eliminate errors in the calculation process. You should also be careful about the use of leverage in trading as it can amplify the profits and losses alike.
Use Stop Loss and Take Profit orders
No matter how much time or effort you put into devising and refining your strategies, a certain amount of risk will always be there due to the unpredictable nature of the forex market and you should always have an exit plan while entering a trade.
The exit strategy includes the use of stop loss and take profit orders to cut the losing trades early and secure the profits of winning trades. Trading without a stop loss can lead to a bigger account drawdown if you are unable to monitor the trades and manage your positions when the market becomes unfavorable.
A stop loss saves you from all the trouble as you can let your trade run freely without worrying about losing a lot even if your analysis turns out to be wrong. Take-profit orders are also used to protect your profits in case there is a trend reversal that turns a winning trade into a losing trade.
Having a clear profit target allows you to exit at a favourable price and such order types are very useful for safeguarding your trading capital. You can also think of using a trailing stop loss order if you want some level of flexibility in these automated exits.
Trailing stop losses are not stagnant like the regular stop loss and it can move based on the market direction. However, the usage of trailing stop loss is more complex as it moves on its own and those who are not sure about how it works should stick to the traditional stop and limit orders for risk management.
The placement of stop loss should be at the right place as a wide stop loss can increase your potential loss while a tight stop loss can limit your profit potential when there is a brief pullback before the trend is resumed.
Another thing to talk about for money management is setting a risk/reward ratio and planning your trades based on that. A favourable risk/reward ratio is important for optimising the profit potential with minimal risk and you need to make sure that the trades you place are worth the risk when you win them.
Conclusion
In a nutshell, money management is a relevant aspect of forex trading success and experienced traders can keep trading for a long period due to their money management skills. Hence, you need to be careful about how you handle your funds and monitor your account performance regularly to keep the account drawdown within the limit.
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