Money Managing In Forex

Money Management 

Don't put all your eggs in one basket. Diversify. Money management is much more than that. Poor money management can turn a profitable system into losses. Good money management knowledge and skills are crucial to a trader's success, even more important then market knowledge.

Risk and Reward

                How do you determine proper risk and reward in trading? I don't think anyone can ever provide a definitive answer to that question because its is akin to asking how many layers do you need to walk outside of my apartment in New York City in the winter. Right now as the thermometer reads a balmy 8 degrees Fahrenheit as I type this at 3 in the morning, you need about four layers just to make it to the coffee shop across the street. But just last week you could have made the same journey in a T shirt without feeling a chill.

Trading, like the addled, globally warmed weather of my great metropolis is an imprecise and a highly volatile proposition. Therefore the question of risk and reward always changes with the circumstances of the moment. The traditional view on risk and reward is to set the ration to at least 2:1 - risking half the amount of pips as you are trying to make, so that if your profit target was 100 then your stop would be 50.

In theory this sounds like a terrific plan. You only need to be correct 4 out of 10 times to make money. However, I've never met a real life trader who actually put this principle into practice. I've received plenty of such advice on this matter from analysts, strategists, trading coaches and a whole host of others who have never wagered so much as their breakfast money on a trade, but I have never seen the 2:1 ratio employed by anyone who actually makes their living from the market.

Why?

The primary reason is that most people who never trade, do not realize that there is no such thing as reward in the market. There is only risk. Markets are not like factories that manufacture profits to your order. In fact, markets do everything possible to frustrate your goals. Imagine a trade where you risk 100 points with a profit target of 200. Initially the trade goes your way and the floating p/l quickly rises until it reaches +199. Disciplined in your 2:1 strategy you wait for the profit target to hit so you can book another good trade. But guess what? The market suddenly stalls and then reverses. You watch in horror as the positive trade quickly turns negative and then drops through your stop. What was you loss? On paper you lost 100 points, but in actuality you lost -299 points ( 100 points on your stop and -199 you did not book). Welcome to real life trading where the �theoretical� 2:1 risk reward is far more elusive than you think.

The fact of the matter is that profits cannot be forecast in the market. The only thing you can control is risk. That's why we always trade with two units. That's why we always take short first targets and that's why we assiduously control risk by trailing our stops. It may not be glamorous, but its the only way we know how deal with risk and reward at BKT.

The Single MOST IMPORTANT Aspect of Futures Trading

                                                                      

Okay, traders: Do you know what is the most important aspect of successful futures trading? Is it identifying the trading opportunity? Is it proper entry into the market? Is it the trading "tools" you are using? Is it an exit strategy that is the most important aspect of trading? The answer is: None of the above (although an exit strategy is close).

The most important factor in successful futures trading is money management. One still has to be savvy at chart forecasting and-or fundamental analysis, but it's the money-management factor that will make or break a futures trader. The huge leverage involved with trading futures absolutely requires pinpoint money managing.

Over the years, I have listened to the best traders in the business talk about what makes them succeed in this challenging arena, and nearly every one emphasizes the importance of sound money management. A few years ago I attended a TAG (Technical Analysis Group) trader's conference in Las Vegas. One of the featured speakers stressed that becoming a successful futures trader should be more an act of survival in the early going than scoring winning trades.

Surviving in the futures market absolutely requires practicing sound money management. Even a rookie trader who starts out with a hot hand will eventually find that at least some trades are not going to go his way. And if he has not employed good money- management principles on those losing trades, he will likely have squandered his trading profits and his entire trading account.

Conversely, the novice trader who uses good, conservative money management techniques will be able to withstand some losses and be able to trade another day. The ability to take a loss and trade another day is the key to survival--and ultimate success-- in the futures trading arena.

Here's an important point to consider, regarding money management and successful futures trading: Most successful futures traders will tell you that during the span of a year they have more losing trades than winning trades. Then why are they successful? It is because of good money management. Successful traders set tight stops to get out of losing positions quickly; and they let the winners ride out the trend. On the balance sheet, a few bigger winning trades will more than offset the more numerous smaller losers. Good money management allows for that to happen.

Good money management" is a relative principle. A good money- management practice for one trader might not be a good money- management practice for another. Here's a real-life example: I had a fellow email me a while back, saying he was up $3,000 in a sugar trade, and that his total trading account was $4,000. Although I don't provide specific trading advice to individuals, I told the trader that if I had only a $4,000 trading account and had racked up 3 grand in profits on one trade, I would seriously think about ringing the cash register on that trade and building up my account so that I could withstand those drawdowns and losers that will eventually occur.

On the other hand, if a trader with a $30,000 account had a $3,000 winning sugar trade, he may want to let the winner ride a little longer, as pocketing the profit would not nearly double his trading account, as it would the smaller-capitalized trader.

In other words, don't be a greedy trader. There's an old trading adage that says there is room for bulls and bears in the marketplace, but pigs get slaughtered.

Let me emphasize here there is nothing wrong with starting out with, or keeping, a smaller-capitalized futures trading account. But I strongly suggest that those smaller accounts use the very strictest of money management.

There are dozens of good futures and stock trading books available, and most spend at least an entire chapter on money management.

Here are just a few very general money-management guidelines:

For smaller-capitalized traders, don't commit more than one-third of your trading capital to one trade. For medium- and larger-capitalized traders, you should not commit more than 10% of your capital to one trade. The guideline here is, the larger your trading account, the smaller your commitment should be to one trade. In fact, some trading veterans suggest larger trading accounts should not commit more than 3-5% of their capital to one trade. Smaller-capitalized traders, by necessity, have to commit a larger percentage of their capital to one trade. However, these small-cap traders may want to trade options (buying them, not selling them), as risk is limited to the price paid for the option. Or, smaller-capitalized traders may want to trade on the Mid-American Exchange, a division of the Chicago Board of Trade that has smaller futures contract sizes.

Use tight protective stops in all your trades. Cut your losses short and let the winners ride the trend.

Never, never, never add to a losing position.

Your risk-reward ratio in a futures trade should be at least three to one. In other words, if your risk of loss is $1,000, your profit potential should be at least $3,000.

I can't stress enough that survival in the futures trading arena (especially for beginners) should be your top priority.

                    

Don't Hold Your Breath Too Long While Under Water

                                                                                   The headline of this educational feature pertains not to swimming but to trading. Most professional traders do not hold onto their losing positions for very long. Once a trading position goes "under water" most professional traders will immediately begin looking for an exit strategy�-if they do not already have one in place (and most do) via protective stops.

I had lunch with my trading mentor the other day and he shared a very good story with me. It went something like this: There once was a trader whose trading decisions were based upon using a "plumb-bob." (For those who have never worked on a construction site or in the land-surveying business, a plumb-bob is a turnip-shaped weight that is attached to a string to help determine if a structure is straight.) When this trader dangled the plumb-bob and it swung back and forth from north to south, he would buy. If the trader dangled the plumb-bob and it swung back and forth from east to west, he would sell. The trader had success using this methodology--with one simple rule applied: At the end of the first day, if his position was "under water," he exited his trade first thing the next trading day.

The moral of the story is: Traders can (and do) have all kinds of trading strategies, but prudent money management is paramount. In other words, cut losses short!

Over the years I have received emails and telephone calls from traders who were way "under water" and had not prudently liquidated their losing trading positions. These traders were "hoping" the markets would turn around and losses would be reversed. Any time a trader has losses which are so big that "hope" comes into play, it's usually a situation where prudent money management has not been employed.

It's also important to mention that traders who know they have waited way too long to exit a losing position should not think already-big losses can't get even bigger--much bigger. I've heard many traders say, "Well, I've lost so much already that now I might as well wait for the market to turn around because it can't go much farther against me." That's a recipe for disaster and potential financial ruin. This is where the saying, "Never meet a margin call" comes into play. If a trader gets a margin call from his or her broker, it's best just to close out the losing position and look for trading opportunities in other markets.

I've often mentioned the old trading adage: "A market will do anything and everything possible to frustrate the largest amount of traders." Guess who are the traders that get most frustrated? It's the ones who are hanging on to losing trading positions, waiting and hoping for the market to turn around so they can get their money back. "I just want to get back to even" is a desperate quote that comes from some traders who are under water. That "hope" is usually never realized.

One of the most interesting aspects of trading futures is that there are a few basic and effective rules that have been used by successful traders for years. However, adhering to these rules on a continual basis can be most difficult for many traders--including the experienced veterans. Why is this? It is because some of the most effective rules in futures trading go against the grain of human nature. Indeed, the "psychology of trading" plays such an important role in trading success.