Many Forex traders, especially beginners underestimate the importance of Money Management when building a profitable trading strategy. Despite of its importance, money management is based on the performance of only two rules which are strict and clear. You must have a clear idea about how much percent of deposit you are using. In order to make your trading accurate and organized pay attention on using these two tools – the lot size and the Stop Loss order.
The usage of Stop Loss is required in order to limit a loss of each transaction. You must set the stop loss order based on the criteria for determining the acceptable loss of every transaction, but not on how much you “do not feel sorry” to lose in each case. A lot size that you choose for your trading position should be such that the sum of all open positions did not exceed 3% or maximum 5% of your total deposit. Defining and changing the lot size is called running an open position. There are two basic principles of the position management:
1. Method of trading with all investment.
This method violates all rules of Money Management. It can not be called the method of position management, but we could not mention it, because there is hardly a single trader who would not use it at lease once in his Forex trading.
The principle of the method is simple, a trader opens a trading position with the maximum number of lots that his investment allows. As a result of such trade, he gets the maximum possible profit, but at the same time, he has the maximum possible risks. Using this method of trading, whatever your trading strategy is, may take you only 2-3 trading transactions in order to lose your entire capital.
This method is popular among Forex beginners who are looking for quick and easy profits as well as traders who take part in competitions on their demo accounts.
2. Method of trading with a fixed lot.
The basics of this method is that before starting trading a Forex trader determines a lot size, which is going to be the same in the future regardless of the trading performance. During this position management the risk is decreasing as the investment is growing, but chances for profit become smaller too.
This method is quite popular among beginner Forex traders that already had a chance of losing their deposit. The disadvantage of this method is that usually after the sum of investment was changed, traders also try to change the lot size, increasing or decreasing it. In this case, when switching to the larger lot size few consecutive unprofitable trades decrease the total capital to its original size. This is the reason why many traders can not increase the size of their investment, although they don’t lose it completely.