Introduction
Did you know that you can lose large sums of money trading Forex, even if you have a profitable Forex trading system? Contrary to what most Forex traders believe, a profitable Forex trading system is not the only end to successful Forex trading. The secret to keeping your trading account safe and growing your returns exponentially at the same time is the little-known practice of Forex money management.
What is Forex Money Management?
Forex money management is basically how much you should risk on each trade, and there are many different money management strategies. A popular example that you will hear often about is the 2% rule, which states that you should not risk more than 2% of your trading capital on a single trade. Most people get confused by this definition because they confuse margin with risk per trade, so I’ll explain it in a different way: if you are using the 2% rule, then you have to size your positions in such a way that it does. do not lose more than 2% of your capital on a given trade. For example, if your stop is 10 pips away and 2% of your equity is $ 200, then you should only take 2 contracts (2 contracts x $ 10 per pip x 10 pips = $ 200 risk per trade)
The limitations of traditional money management in forex trading
Most people religiously follow the 2% rule without knowing why they should. I personally believe in knowing why I am doing something before doing it, so I researched this thoroughly. It turns out that if you want to minimize the risk of blowing up your trading account while maximizing your long-term trading profits, then you’ll want to keep your risk per trade between 2-4% of your trading capital. Depending on your own risk tolerance, you can actually go as high as 3% or even 4% to further increase your profits, without greatly increasing your risks.
The Secret Exponential Money Management Method
The 2-4% Forex trading money management model is a type of geometric money management technique and is the most efficient way to grow your capital when trading Forex. Traditionally, people apply Forex money management using a fixed contract size, which is good for small accounts but not very efficient. The reason the 2-4% rule is so powerful is because it allows you to apply the power of compounding to your trades. As you make profits, you reinvest them over and over again, creating an exponential growth rate in your trading account. I’m sure you will agree that when it comes to your trading profits, an exponential increase is much better than a linear increase.
The power of the 2-4% rule
There are two ways to apply the 2-4% rule. One is to update your position sizes at the end of regular time intervals, and the other is to update your position sizes at specific profit / loss milestones. Regardless of which method you apply, it is clear that the 2-4% rule is powerful because it creates the fastest and safest growth for your trading account. Obviously, you will need a profitable Forex trading system to successfully implement this Forex money management strategy. Once you have these two components in place, nothing will stop you from creating a consistent passive Forex income that grows and grows over time!
