Why Money Management?
Best system will fail in long-term if it is without proper money management. On the contrary, bad system can turn profitable if used with a good money management. Currency trading always go through the cyclical ups and downs, where winning and losing are just part of the game. However, with the right money management, you might be able to hold onto your winnings, while minimizing losses during bad times.
Have you ever wondered why you made so much profit so easily only to lose all of it plus your principal in a flash? Then you’re trading without a proper money management. You’ve got to be disciplined, or your winnings are guaranteed to lose sooner or later. Learn these money management techniques today!
Alexander Elder’s 2% and 6% Rules
First and foremost, note down your account equity at beginning of the month. Then compute 2% and 6% of the account equity. For example, if your account equity at the beginning of the month was $100,000 then 2% of $100,000 was $2,000, and 6% of it was $6,000. But what are these numbers used for?
Firstly, you should never risk more than the 2% per trade. This will protect you from blowing up your account from just a few bad trades. In this example, the maximum loss of any single trade allowed is $2,000 (the 2% of $100,000). Make sure that you don’t expose more than that in any trade. To enforce this rule, you have to set stop loss to limit the loss at $2,000 or less. That is usually a stop loss of at most 200 pips for a 1-lot contract or at most 50 pips for 4-lot contract. Remember that you can always set stop loss less than the 2% or execute multiple trades. Just make sure it is not larger than that.
In addition to the 2% rule, you are allowed to risk a maximum of 6% of equity in one month. In this example, allow yourself to lose not more than $6,000 (the 6% of $100,000). You may open multiple trades running concurrently, but make sure that in total you are not exposing more than $6,000. Any time you see drawdown of current month exceeds $6,000, stop trading until next month. Then in the new month, you’ll have another 6% to risk. Always check that if all the open trades are lost, they won’t take more than the %6.
Assuming at the start of ‘new’ month, your account equity is now down to $94,000. The 2% of $94,000 is $1,880 and the 6% is $5,640. In this ‘new’ month, you may risk a max of $1,880 per trade and a max of $5,640 per month. You have to set stop loss to all trades to make sure that these rules are always enforced. Recalculate the 2% and 6% at the beginning of every month and trade accordingly.
While traders should always note that Forex trading involves a substantial risk of loss, these two rules can help you save your precious money during bad times, while you hopefully grow your money during good times. The 2% and 6% rule can help cut the losses short.
Apply this money management to your trading today, get disciplined and become professional trader.