A mentor of my own once taught me, “the difference between playing and investing is education”. In Forex, possibly more than anything else, this statement poker88 stands true. I would like to add one aspect fot it statement though. The difference between Forex trading and Forex Playing is not only education, but proper a money management plan.
So what do i mean when i say “a proper money management plan you may ask? Well, learning how to trade Forex is more than just studying technical analysis, creating a Forex trading system, and trading that system. Even the best Forex trading system will lose with out proper money management. A money management plan is a plan for how the total account balance will be affected but each individual trade in a trading system. Your money management plan gets you through the losing periods and back to winning.
A money management plan ought to include several key components.
What percent of my overall account balance can i risk on every trade? This number can vary depending on the system and signal types. It should however be consistent across every trade. For instance, lets say you have a moving average system that takes trades off from both a one hour chart and a day chart. Every day signals may be higher probability signals but come less often. Your money management rules may call for endangering 1% of the total account balance on every daily signal and 1/2% of the total balance on the constant signals.
What is my maximum daily and overall maximum drawdown? Some plans look at what a bodies maximum drawdown has been during the last few years as well as the average daily maximum drawdown. The plan then could will include a rule that states I will stop trading today if my account balance draws down 2%. If the system in general draws down more than 25% at any time I will stop trading. This is your maximum risk limit. A daily maximum helps you stop trading when emotions could get the best of you and the overall maximum drawdown helps you determine at what point I may need to reassess the effectiveness of my system.
At what times can i withdraw profits from my account? I am not talking about taking profit on individual trades. After all actually pulling profits from your trading account. Pulling profits must be balanced with compounding profits. There is a delicate balance between the rule as to when profits should be taken depends on the investor and his/her trading strategy. My Forex money management plan calls for pulling out 50% of profits on a quarterly basis. Some may take profits monthly yet others yearly.
What is my maximum Border level? This refers to over trading. Some traders may think, I have all this available border, why not use it? This can be a dangerous thinking though. Every dollar margined puts in danger the overall balance of the account. You can also make money faster but you Will lose it faster. Using too much of your available border puts you in the realm of playing. Markets can move quickly and even if you have a stop-loss that is suppose to keep you from losing regarding green small percent of your account balance, drastic news could move a currency far past your stop-loss producing a much wider loss than your money management plan had anticipated. Keep at least 50% of your border available for use. Never trade less than $1000 with a tiny account, $10000 with a mini account, and $100, 000 with a standard account. Your money management plan should have rules in place in the event border falls below certain levels.
These are just some of the components that make up a proper money management plan. In short, your plan should figure out how much you will risk and with how much you will trade every trade. Following a well written, well considered plan will help you be a successful Forex trader rather than a risk taking Forex gambler.