If you have been around Forex trading for a while, I am sure this is not the first time you hear that the real key to success is not just to know when to enter or exit the market, but also a good money management strategy. Money management will also be discussed at http://www.forexmeetingpoint.com soon, so make sure to check that website out as well!
A good money management strategy should protect your capital and achieve as low losses as possible and as high profit as possible. It sounds almost self-evident, yet there are still too many people who break these simple rules.
First off, let’s take a look at how your money management strategy should NOT look like – one of the examples is a strategy called „martingale“. What it does is that after every loss, you increase the trade size (which is actually the opposite of what a good money management strategy does). Originally, this strategy was used when playing roulette, however, some people try and implement it in their money management strategies.
The logic behind it is that if you lose a trade, you should win that amount and then some in the next trade. The problem is that sooner or later, this strategy will result in wiping your account out in just a few trades – either simply because of the size of the loss or because of not being able to increase the trade size anymore due to lack of available leverage.
The best money management strategy to use is probably the best known one – simply set a risk percent per trade and adjust the lot size after each trade. How much should we risk per trade though?
First off, pick a level of drawdown, which you never want to surpass. Second, look at the results of your system from the past (at least 2 years back). Your risk percent setting should generate a maximum drawdown of half of that value on the backtest.
Now if you ever get to the point when you actually reach the maximum drawdown you set, you should discontinue the trading of the system and start paper trading it for a while to see whether it picks up again, because if the drawdown reaches double the size than ever before, it can mean that the system is breaking down or that the backtest isn’t reliable, which is actually the worse case, because if you though it worked for a few months, it could just have been a lucky period
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