Forex Money Management â€" No-Nonsense Style by Tim Barnby

If a Forex trading system promised to (and you KNEW it would) consistently make you money, would you pay $1,500.00 for it? How about signals? If you knew that a signal provider would make you $2,000.00 per month, would you pay $1,500.00 per month for the service? Of course you would. You’re smart enough to add and subtract. If you wouldn’t pay $1,500.00 for signals that produce $2,000.00, please do us both a favor and switch from trading to something in the retail industry or something. Perhaps a Wal-Mart greeter?
Would you pay $1,500,00 for a forex money management system? Ummmm…probably not. I’ve actually asked these questions in my trading room. Clients almost always answer the questions the same way. Of course they will pay top dollar for profitable systems and signals. When it comes to money management and the mental-game of trading, they answer negatively. There are reasons for this that I’ll get into later. This is a money management article.
There are probably more than 100,000 different Forex systems available for purchase on the Internet. Some of them are good and some of them are crap. All of them will make pips when the market is in tune with their signals. I say that they make pips because they don’t necessarily make profit. Positive pips counts do not equal positive equity. Pips and profit do not have a strong positive correlation. I have proven this dozens of times in the past and will prove it again on my website in a video. I know, I know…you’re tired of seeing that you canm lose 300+ pips while gaining money. If you’re tired of hearing it and still losing money, you might want to take a serious look into your goals.
People are superstitious. We think we have a $10,000.00 account even after a 30% drawdown. We always try to sling a big line, no matter what our current financial condition is. Even worse is the poor guy who has to “get back” at GBPJPY for the 300 pip loss he took in the previous trading session. A trader can’t get back at the market. The market is bigger than all of us, and she’ll take what ever we offer her, whenever she wants. The idea behind money management is to not offer her much (even less when we’re losing) and take more from her when she’s generous. Proper money management will protect you from yourself. Money management is no different from everything else in the trading profession. It’s a series of steps that are taken every single time you trade. When I wake up in the morning I put on my pants before I step out the door. When I get in the car, I put the key in before I drive away. When I open a trade, I follow my money management steps. It’s that routine. It’s so routine that it requires absolutely NO THOUGHT! No deliberation, no self-negotiation. There are no exceptions to trading rules. I view trading rules much like I approached combat in the Army. Exceptions get you killed! Excuse yourself one time from following your rules and your blood will be sprayed all over the room. Get it? Do you see how important it is to follow these rules? Just in case you didn’t get this earlier, I’ll say it again here: There are no exceptions to money management rules. If you break your money management rules, I’m going to be spending ALL of your money instead of a little bit of it. Remember that every trader in the market wants you to lose. It is a market. We’re traders, not investors. We make a living speculating on psychology, supply and demand. Even the best system has long periods of drawdown.
When a non-professional trader is on a winning streak, he tends to attribute it to his trading genius. The next Jesse Livermore gets five winning trades and is now a guru… This is the point where he makes a fatal mistake. He places a trade…a big trade. He takes his $13,000.00 and puts on 5 standard lots. Why not? He is a Rock Star trader now…a real veteran. Price turns against him by 20 pips. He can’t stand the thought of losing $1,000.00 in five short minutes, so he moves his stop loss. He fools himself into thinking that he made the right trade. The market is just acting wrong. It’ll turn around for sure. Another 20 pips should do it. An hour later, price is almost to his new stop loss. He’s now about to lose $2,000.00. He can’t lose. The market will turn around. He moves the stop loss back by another 100 pips this time. He goes to bed knowing his position is safe. It’ll never move another 100 pips against him. After all, the 15 Minute trend IS Bullish and the 5 Minute stochastic is already almost over-sold, and the MACD is clearly in an up-trend. He can almost smell the leather in the new Porsche he’ll buy with the winnings from this massive trade. He wakes up and rushes to his computer. He sees that his trade is closed out…his new balance is $5,000.00. He sees that he’s gotten a margin call. All that he has left is the money that he had leveraged. Don’t laugh. I know the guy that this exact scenario happened to. He’s since become an excellent trader.
If the same trader had used sound money management and risked 3%, he’d have hit that 20 pip stop loss and easily swallowed the $400 or so loss. His mistake was what I call “trading beyond the sleeping level.” If you find yourself worrying about a trade, you’re risking too much. Let me make sure you understand that…if you cannot sleep, go to dinner with your spouse, go golfing, or spend 6-8 hours doing whatever without thinking about your open trades, you’re risking too freaking much money! You MUST Trade down to the sleeping level. Your success as a trader depends on this. There will be future articles on the mental game of trading. I just told you the secret of the mental game though.
Here are my money management rules. I’ve modified them a bit from earlier versions so take a look even if you have already read my money management system:
1. When you begin trading, risk only 1% of your base capital. 2. Reduce your equity by the amount of the financial risk for any open trades. 3. After 3 consecutive winners, increase your risk to 2.5% of your base capital. 4. After 1 loss, reduce risk to 2% of base capital. 5. After two consecutive losses, reduce risk to 1.5% of base capital. 6. After four consecutive losses, reduce risk to .5% of your base capital. 7. After two consecutive wins, we reset back to 1% risk per capital and move back to step one. 8. Between 1 June and 1 September, and between 15 November and 15 January, I risk no more than 1%.
My method isn’t the ONLY way to manage your forex trading. It’s certainly not the most profitable. It works for me. In fact, I use a different money management system on my income account than I do with my growth account. This system has proven to build my equity consistently. Even if you choose to trade a set percentage, which is absolutley valid, be consistent in your money management. Trading this way will help you profit, relax, and sleep like a baby even with open positions.