Money management is a way traders control their money flow: in or out of pockets... Yes, it's simply the knowledge and skills on managing a personal Forex account. Let's take a look at calculations where a trader has lost some part of his account. How much effort will it take to recover the original account balance?
There are several rules of good money management:
1. Risk only small percentage of total account
Why is it so important?
The main idea of the whole trading process is to survive!
Survival first, and only then making money on top.
One should clearly understand, that Big traders first of all are skillful survivors. In addition, they usually have deep pockets, which means that under unfavorable conditions they are financially able to sustain big losses and continue trading. For the ordinary traders, the majority of us, the skills of surviving become a vital "must know" platform to keep trading accounts alive and, of course, to make good stable profits.
Let's take a look at the example that shows a difference between risking a small percentage of capital and risking a bigger one. In the worst case scenario of ten losing trades in a row the balance of trader's account will suffer this much: Trades Account balance Risking 2%
of total account per trade 1 Start — 5000 100 2 4900 98 3 4802 96 4 4706 94 5 4612 92 6 4520 90 7 4430 89 8 4341 87 9 4254 85 10 4169 — 17% of the account has been lost Trades Account balance Risking 10%
of total account per trade 1 Start — 5000 500 2 4500 450 3 4050 405 4 3645 364 5 3281 328 6 2953 295 7 2658 265 8 2392 239 9 2153 215 10 1938 — over 60% of the account has been lost
Apparently, there is a big difference between risking 2% and 10% of the total account per trade. A trader who has made 10 trades risking only 2% of balance per trade, under the worst conditions would lose only 17% of the total account. The same trader who had been exposing 10% of balance per trade would end up with loss of over 60% of the total account balance. A simple money management rule — significant results.
2. Rebuilding of a shrinking account is harder that it may seem to be Account % of account lost New balance Need to make $ 5000 25% $ 3750 35% of the new balance ($ 1250) to cover losses $ 5000 50% $ 2500 100% of the new balance ($ 2500) to cover losses $ 5000 75% $ 1250 300% of the new balance ($ 3750) to cover losses Note that it's only to cover losses: Who is going to make money then..? And when?
Now, there is a challenge: try on your demo account to rise up 300% or at least 100% of your original account trading as it would be real money. Will that be easy? I don't think so. Can you prove me wrong?
