Effective money management: reliable protection of your capital

Money management for those who respect their money

An incredibly successful player described modern money management most accurately: “It doesn’t matter how often you are right or wrong — it only matters how much you make when you are right, versus how much you lose when you are wrong”.

Found out who? Yes, it’s the principle of outstanding George Soros.

Today the proper money management is necessary not only for the losses control but for an optimal choice of entry points and safe position closing as well.

You must learn to think like a banker, who not only multiplies but saves their investment as well — only then it will bring a profit.

The choice of the method depends on a risk level suitable for a trader: some people need confidence and assurance, while the others need a quick profit.

Let’s look at it in detail.

Full capital method

The simplest yet dangerous method: we enter the market with max volume, max risk and no Stop Loss.

Even if you are 100% sure about the correctness of your deal — such trading finishes quickly, since there’s no right for mistake at all. One failed deal kills the entire profit with the deposit.

Such “all in” on the financial market is an absolutely unjustified risk. However, there is a scheme when one can earn even with such money management.

We invest the initial capital into a few trading accounts (multiple brokers are possible), where we trade “for the whole bank” using various assets, periods and strategies. As a result, trading depends less on large loss-making deals and gives an opportunity to test a few strategies.

At some moment the trading stops, money is gathered in the one amount taking into account the loss-making/profitable accounts, and a part of the profit is monetized.

The rest of the amount is once again distributed on a few accounts and the scheme is repeated.

The result?

Such trading is very difficult psychologically. It can be applied, for example, through participation in a contest on cent or demo-accounts, where the maximum result is required and there no real losses.

Even a short-term “acceleration” of the real deposit with such a method is very dangerous: a stable strategy is required, with which an average profit surpasses an average loss 3-5 times as a minimum.

But if a trader has such a methodology, why risking so much? It’s better to calmly trade with less dangerous deals.

Constant amount method

A trader defines the fixed loss amount, comfortable for themselves both financially and psychologically. If the estimated risk surpasses the allowable loss level, then such a trading signal is skipped.

The risk is controlled through the right estimation of the position volume taking into account the rest of the deposit.

The result?

This is a simple method, without difficult calculations, beginner-friendly. But if the level of the fixed risk remains unchanged, the amount of “idle” capital, not engaged in trades, grows.

Moreover, in the case of loss, the risk will grow in percentage terms. What this means is with changes in the account balance, one will have to adjust the size of an allowable loss.

For example, if for $5000 the accepted risk is $500, then for $1000 the acceptable risk can be increased to $750, and with decreasing the balance to $3000 — decrease the risk to $200.

Fixed percentage method

The risk for 1 deal is defined as a fixed percent from the deposit balance and remains unchanged during the work.

The recommended percent is usually chosen in the range from 2% to 10%, but this value must be psychologically comfortable for a trader.

After having the risk level chosen it is necessary to calculate the working lot, and it is recommended to do the recalculation after every deal or after a short series of deals, and hence it is reasonable to automate this process.

Let’s see the example.

The raw data for the risk analysis: the deposit of $20000, allowable risk 2% or $20000*2%=$400. We define the size of Stop Loss manually in the points according to the trading strategy.

In this case, we begin with Stop Loss at the distance of 50 points from the entry point, that is with a failed deal with a minimum volume of 1 lot (the point price is $10), the loss will be $500.

To calculate the maximum lot we must divide the maximum risk by the risk of the loss from the minimum lot.

The result?

The method guarantees stable changing of deals volume towards the deposit. The capital growth causes the growth of the volume and expected profit.

In case of a failed deal we can quickly decrease the lot size lower the loss percentage. We can consider the asymmetrical lever effect a disadvantage — to restore the losses we will need a bigger profit in points.

The method is considered disadvantageous for small deposits: the recommended 2% may be not enough for the minimum deal volume — we have to increase the allowable risk level.

Permanent Lot Method

Under any strategy, fixed lot size is used (contract — in case of futures), which doesn’t rely on the deposit and remains unchanged in the trading process. But there are two problems:

  • if the deposit grows, the trading effectiveness falls through the permanent lot;
  • if the balance shortens through the current losses, the risk grows in percentage terms.

To solve the problems, it is recommended to adjust the deals volume after all: if the trend is profitable, one may increase the lot; if there are losses - we act in reverse order.

Here is an example:

The result?

A simple mechanism for money management is suitable for beginners. The profit dynamic is slow but safe: the risk to lose the deposit as a result of a series of loss-making deals is low. In practice, only the modified version is used.

Fixed proportion method

To try controlling both the profit and risk simultaneously, you can apply the Ryan Jones’s methodology from the book “The Trading Game: Playing by the Numbers to Make Millions”.

At first, a profit is rather small, but if the strategy in principle is profitable, then the profit growth tempo increases and the risk goes lower for one deal.

The Delta term is used in calculations — it is the profit level under which it is possible to gain the size of the working lot.

The Delta value is chosen according to the strategy dynamic: the lower is the value, the more aggressive is the money management. The bigger is the Delta, the more conservatively you will have to trade.

Example: the initial deposit is $10000, the Delta is $5000, the initial volume will make 1 lot. Then, to get the right to increase the working volume to

  • 2 lots — you will have to get $5000 and increase the balance to $15000 (10000+(1*5000));
  • 3 lots — to get $10000 more and gain the general account to $25000 (15000+(2*5000));
  • 4 lots — add $15000 more and get the balance of $40000 (25000+(3*5000)).

The lot volume grows as far as the capital increases, but the risk goes down because the sum for the guarantee support grows as well.

In case of losses, it is disadvantageous to decrease the lot size. It is more logical to lower the Delta value, for example, for 25-50%.

This will allow us to slow down the subsidence tempo and reduce the impact of the asymmetrical lever.

The result?

The main condition for this scheme — the availability of a statistically profitable strategy, only then the method will provide control over the losses tempo in unfavorable time.

The weak tempo of the profit growth compared to more speculative money management can be considered a disadvantage. Using this strategy is recommended only to experienced traders.

Several practical remarks

We assume that our readers see themselves not as random speculators, but as professional players, whose goal is to stay at the market as long as they can and earn steadily.

It is necessary to find an optimal balance between the allowable risk and a possible profit in every deal; by changing the position size, a trader must get the maximum effect from their actions.

We remind you the basic rules of money management for affirmative actions on the market:

  • conduct the risk analysis and calculate all parameters (the lot, allowable subsidence, pressure on deposit, Take Profit/Stop Loss, the loss compensation method);
  • follow the proportion between Take Profit/Stop Loss — no less than 2:1;
  • define the tactics of behavior in different market conditions before opening the first deal;
  • start trading with the minimum lot and change it only according to the strategy;
  • never leave the minimum margin level;
  • under the lack of budget and margin call threat, close the most loss-making position;
  • use the faster deal volume reduction than rising with the subsidence to protect the profit.

Of course, all money management schemes haven’t fit into one article. In parts two and three, we will:

  • show you the “Pyramiding” method for getting the maximum from the trend trading;
  • address the traditional for the stock market methods of the safe and optimal share;
  • research famous Martingale and its less dangerous versions of “Soft Martingale” and “Martingale with progression”;
  • offer a few more little-known systems for the curious ones.

Try It Yourself

In order to try these money management tips or other ones, no need to risk at youк live Forex account. Simply  Forex Tester for free. In addition, you will receive 23 years of free historical data (easily downloadable straight from the software).

This way you can spend as much time as you need to sharpen your money management skills and grow your confidence as a professional trader.

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