One of the main reasons why over 90% of new Forex Traders lose their entire accounts within a few months is that they fail to understand that their new profession entails high levels of risk.
To counter this problem, they need to grasp the concepts of good money management as quickly as possible.
Although mastering money management does not always in itself bring profits, it does contribute to protecting existing profits, or prevent fatal losses. It is essential in ensuring the longest length of survival as possible. The best Forex traders become first extremely adapt at surviving before achieving profits.
Money management involves techniques that essentially show you how to lower risk in trading and by doing so will greatly assist in preserving your account balance. These strategies will show you how to become a profitable and successful trader. For example, one of the major differences between Forex experts and novices is that experts have obtained an astute understanding of the facets of this subject.
The fixed risk ratio is one of the most straight-forward Money Management strategies and is based on the concept that you must never risk more than a pre-determined percentage of your account. The most popular risk ratio at present is 2%.
Risk exposure is restricted to this recommended value by controlling and adjusting the position size and stop loss of each trade accordingly. Position size represents the total amount invested per trade whilst a Stop Loss determines the amount placed at risk per trade.
Many inexperienced traders just enter positions by only considering their profit potentials and without controlling losses by correctly calculated stop-losses. As such, their results tend to be disastrous.
Why is money management so important? To answer this question, let us consider the following simple example. Assume that you created or obtained a Forex trading strategy that has a win to loss ratio of 90% ie 90 of 100 trades will be success. However, you still don't know when the 10% of losses would occur. Let us take the worse case and assume they are the first 10 results that you obtain before achieving any winners.
Now, if you were unfortunate to experience this sequence and risked 10% of your account per trade, you would be left with just 34% of your entire balance at the end. In contrast, should you have just risked 2% per trade then you would still have 82% of your balance intact. Obviously, the second scenario offers you much better protection and survival prospects.
You need as much time as you can obtain in order to select or create a winning forex strategy. Volatility, in particular, impacts many viable strategies these days by reducing their profit potentials dramatically. This is because too many human emotions are invoked in rapid succession weakening traders' concentration and mental fortitude to a minimum.
To combat these problems, you need to utilize the concepts of Money Management in order to provide yourself with the ultimate time period in order to find a winning strategy. In addition, you need to segment your total account balance into the maximum risk amount that you are willing to take before need arises to re-assess your trading strategy.