Written by MPL1983
Those who have been reading my previous articles will notice that I always start the title with EUR/USD, although one could argue that the subjects you read could be applied as a general rule of thumb for all markets, I would disagree. I believe that each currency pair would deserves its own tailored strategy in all areas, technical, fundamental, leverage, allocations, and in this article on money management.
There’s a saying that most of us would have heard at one time in our life “To gain respect – you must give respect;” this of course, would be applied to us humans interactions, but for me personally and as one of my many rules I also apply this to the Forex market. Fear the market, respect the market, and never underestimate the market, as if you don’t apply these rules, the market will eat your SL’s, one by one, followed by your whole account, and in some cases, your mind.
A very well known saying in poker is “Tilt,” someone who loses some playing hands then bets with emotion without any logic, though, thus losing – this can also be applied to the Forex market if you’re not careful. There’s no pride lost in having fear, some of the world’s best climbers fear heights – this is why they are the best and rarely fall, they fear, become more careful , and achieve their goals – which in most instances = success – being some of the best.
Some who read this may scratch their heads thinking, “what has this got to do with money management?” EVERYTHING. Mentally, your mind really needs to be in the right place before you can attempt to make logical decisions and technical calculations. Someone posted a question on my wall recently asking how much money I thought they would they need to start with to become a low risk trader. What a great question to ask – the right question in my view.
For somebody new to Forex who is looking to become a serious trader, and to stand a good chance of becoming a successful investor, I would suggest a starting capital of a minimum of $1000, in my view. This would enable you to execute X25 leverage trades of $40, which would be a 4% allocation of your overall account per trade, which will also enable you to open multiple trades at different technically-calculated pricing points (entries). This would then give you a good margin of error to safely absorb any over traded moments. With my strategy I do get draw downs on trades which I expect, but to what level none of us can really be 100% sure – this is why we need the protection provided from a good money management strategy.
I read a book a while ago on investing, and for me has to be, by far, the best and most inspirational book I have ever read on investing; it is called “Taming the Lion,” written by a very successful investor, Richard Farleigh. There are many great ideas you can get from this book, but for me, there is one part of this book that has stuck with me the most, and has become part of my many rules when analyzing and making trading decisions.
I can’t take credit for this but it’s something I would suggest taking note of when trading. We often see draw downs in trades we execute, that’s part of Forex, and part of my strategy when buying the dips at various technical levels ready for the re-drive through to my TPs. This is not word for word, but Richard Farleigh talked about how far should you let a trade draw down before cutting your loses. The decision to cut your losses should primarily come from fundamental analysis, and from that, if you can apply fundamental reasoning for a draw down, then now may not be the time cut your losses, as fundamentally there may be a bigger picture in your direction that favors that which has caused the short term draw down.
For example, based on recent events, I have been bullish on the EUR/USD pair, and shared the same view with the investors in anticipation of a drive on the euro with the Greek bailout proposals, IMF bailout funds proposal, the Federal Reserve Chairman Bernanke’s testimony (if you watched, you would understand), amongst many other factors. In the medium-term, that has driven the price back up from 1.26 to 1.33, but in between these prices there has been lots of ups and downs and ranging. So, as purely an example, if I entered a buy trade at 1.31 and the price fell to 1.30, I wouldn’t cut my losses at this stage so long as I can apply fundamental reasoning for the short-term fall leading up to the medium-term events that should drive the Euro back up.
The short fall could have been caused perhaps by downgrades or further delays in austerity agreements, but in my mind I have the medium term events to consider and with the anticipation I feel confident that the price would rise again in the lead up to another set of austerity agreement dates or a possible sign off of the agreement. As I said, these are just examples given the more familiar events among many others, all of which could cause these movements.
But when do we actually cut our losses? As Richard Farleigh so aptly said – if you cannot apply any fundamental reasoning (and technical, in some cases) whatsoever, thus not understanding why the price may have fallen say by 200 pips (with signs of a further fall) and with no explanation, then this may be the time to cut your losses, sit back, reflect, and stay away from the market until you can find solid reasoning.
Luckily for me, I have never had this happen to me yet, but one day it may happen, who knows. You see, with high risk trading, you can’t absorb these movements without topping up your accounts and digging an even bigger hole. Some may know what fundamental events will cause these draw downs, but none of us can really say when it is going to stop falling.
But with the right money and risk management, we can prepare ourselves for most unpredictable events, which happens more often than not with this pair. I personally start allocating around 2% per trade, and as the draw down deepens I will then start opening positions around 4% per trade, but only if I can apply fundamental reasoning for the draw down and see a re-drive in sight in the medium term. Doing this allows me to execute a minimal loss plan if things got really bad and out of control, by covering the initial smaller executions with profits from the lower entry larger allocations.
Finally, the most exciting part of lower risk trading for me is the profits that can be made, if you get it right. Why open 1 or 2 high risk trades allocating a lot of your account for maybe 10 pips, when you can have say 10 trades open at different levels depending on volatility and, easily, with no stress or worries, gain up to 100 pips per trade. And the bonus of low risk trading is that you can comfortably sleep at night.
So, a final note to end this article with – bear in mind when entering a trade that if you can enter a trade and walk away from your trading screen for a few hours with no worries – then it’s probably a well placed entry from a risk/money management view. If, for some reason, you don’t feel you can walk away when entering the trade – then you probably need to re-think your strategy, as again, from a risk/money management view, the strategy being used is too risky.
I hope all this makes sense and helps. Please remember, there are many other successful strategies out there from other great traders; this one works for me, and that’s something important to take note of when finding a strategy that works for you.
I wish you all the best of luck and success in trading.
This news item was republished from eToro Forex news website
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