Developing money management skills enables traders to properly allocate their positions while staying true to their risk tolerance levels. Money management should therefore be an indispensable part of a trader’s overall trading strategy. Oftentimes, the importance of proper money management is overlooked, and this is why in this article, we will be disclosing three key steps in developing money management skills for trading.
STEP 1: Discipline
As human beings, traders can often be driven more by their emotions, than by their common sense; it is therefore important to ensure that they have set concrete money management rules that they can abide by. For example, the size of your overall risk capital should always be a factor when determining the upper limit of your position size. Another way to aim for the correct level of risk is to adjust your position size to reflect the volatility of the traded pair. It is prudent for example to keep positions much smaller when trading highly volatile pairs or assets.
STEP 2: Handling Losses
The ideal case scenario when it comes to trading is letting profits run and cutting losses short. But that is much easier said than done! It’s therefore essential to be able exit quickly when there’s clear evidence that the markets are moving against your trades. It’s a natural human tendency to try and turn a bad situation around, but it’s also a very common mistake that has wiped a great deal of accounts when it comes to FX trading.
The markets are beyond your control and it is important to think about what your “contingency” plan would be if a bad scenario were to unfold. Do not underestimate the chances of price shocks occurring.You don’t have to delve far into the past to find examples of price shocks. In January 2015, the Swiss franc surged roughly 30% against the euro in a matter of minutes. It is always useful to study the markets for past such extreme scenarios and prepare for the most adverse situation.
STEP 3: Understanding Leverage
Leverage offers the opportunity to multiply profits but can also magnify your losses should the markets move against you. A very high leverage ratio may wipe your account clean as you are essentially trading on “borrowed capital” while you are covering the losses from your own funds. Leverage is a very a useful tool, but it is very important to make sure you understand the size of your overall exposure.
*Please note that this article is not meant to be construed as investment advice or suggestion of an investment strategy with respect to any financial instrument.
Sources: Investopedia, ForexCrunch