Showing posts with label money management. Show all posts
Showing posts with label money management. Show all posts

Understanding the Money Management in trading

I've always emphasized the importance of the MM in Forex, in my articles. Yet, many people failed to understand it properly.

Therefore I will take it, again, step by step from the basic theory.

Currencies Rates

The currency Rate is the value of one currency expressed in terms of another.

Common rates can be seen as: EURUSD = 1.3025

This can be read as 1 EUR = USD 1.3025

The first currency (EUR in our example) is the "Base currency" and the second one (USD in our example) is the "Quote currency".

Bid and Ask prices

EURUSD = 1.3025/1.3027

The first rate (1.3025) is the "Bid" and the second one (1.3027) is the "Ask"(Offer).

If you want to "Buy" the "Base currency" (EUR) and "Sell" the "Quote currency" (USD), you will use the "Ask" price.

If you want to "Sell" the "Base currency" (EUR) and "Buy" the "Quote currency" (USD), you will use the "Bid" price.

The difference between Bid and Ask is called Spread (in our example spread = 2 pips).


Pip = The smallest price movement on a currency. Also known as a "Tick size".
e.g. 1 pip = 0.0001 for EUR/USD, and 0.01 for USD/JPY.

Leverage & Margin

Leverage = multiplying factor that allow you to trade more money than you have into your account.
Margin = the amount of money, necessary to open a trade

Leverage 1:50   = 1/  50x100 = 2% Margin (requirement)
Leverage 1:100 = 1/100x100 = 1% Margin (requirement)
Leverage 1:200 = 1/200x100 = 0.5% Margin (requirement)

So let's say you want to trade $100,000. By using a Leverage of 1:100, that means you will need a margin of just $1,000 (1%).

Trading using the Leverage might work in your favor if you are right, but can also take you to the bankruptcy, if the trade goes against you.

Here is an example:

Trader 1 have Initial Account balance = $3,000
Trader 2 have Initial Account balance = $10,000
Trader1 use as Leverage = 1:200 = 0.5% Margin = $500
Trader1 use as Leverage = 1:50 = 2 % Margin = $2000

Trader1 and Trader 2, want to buy $100,000, each.

Scenario 1:
Lets say both traders are right and their trade work in their favor with +100p = + $1,000

For trader 1 = +33.3% from Account Balance
While for Trader2 = +10% from Account Balance

Scenario 2:
Lets say their trade went against them with -100 pips = -$1,000 from the Initial Account Balance.

For trader 1 = -33.3% from Account Balance
While for Trader2 = -10% from Account Balance

Even if for some traders looks more profitable to use higher Leverage, due to their small accounts, if their trades work against them, this will ruin their account. Ofcourse they might be tempted to use a high Leverage (smaller Margin) so they can trade a much higher volume.

Lot size

In Forex, we dont use Base currencies for the trade volumes. We use Lots.

1 Lot = 100,000 units (full Lot)
0.1 Lot = 10,000 units (mini-lot)
0.01 Lot = 1,000 units (micro-lot)

In our previous example is obvious that if the trade work against you, and you traded a huge volume, the loss is highly important, as the expected profit.

Trader 1 have 3 potential negative trades until he will ruin entirely his account. While Trader2, can afford 10 trades, for that.

You know what they say: "A rich man is a man who can survive longer, without having anymore income". Same as in trading. It doesn't matter how much you can pull out of a trade, but how many negative trades you can take and still be in the market.

Risk/Reward Ratio

Also known as R:R ratio, it means the ratio between expected profits and potential losses.
I don't recommend a R:R lower than 1:3. That means for any loss you might have, you must take at least (minimum) 3 times more from the profitable trades.

TP = 3 x SL

This isnt a random number. This is related to any strategy statistic.
You all know, that you can't have profitable trades, only. So your strategy statistic can be from 5-9/10 trades in profit:

  • min 5/10 since you can have 2 option on any market: buy and sell. So you can have 50-50% to be right on any trade. 
  • max 9/10 since you cant be right all the time.

So, in order to reach your profitable trades, you must be able (afford) to take those losses.

Ofcourse, I prefer to use a much more significant statistic for any strategy, like x/100 trades. Because this offer me a better understanding of the strategy on a longer period of time.
Imagine a 9/10 strategy might be less than 90/100 on a longer period of time (and trades).
What if those 10 negative trades will come, in raw, while starting to trade that strategy ?

Well, you must be prepared for that, as well. You need to still be in the market, when those profitable trades will come.

Money Management

I'm sure you all heard about "Money Management Rules". But what is this really means?

Well, you can consider it a "healthy" way to be in the market longer. Or how much negative trades you can take, in the worst case scenario.

For doing that you need to be able to calculate 2 main things: Volume (as no of lots) and Stop Loss (in pips) for your trades.

I wont develop here the calculations behind the mathematical probabilities of a strategy. All you need to know is that you should use these numbers, as beginner:

Max Risk/Trade = 2%
Max Investment = 15%

(take as example our previous exercise for the Trader1)

Example of MM Rules:

Account Balance = $10,000
Max Investment = 15% = $1,500
Risk = 2% = $200
Leverage = 1:100
EURUSD = 1.3025

How many lots can you trade?

1.0 lot = 100,000 EUR => Margin =1%=1,000 EUR =$1,302 (1000 EUR x 1.3025)

0.1 lot = 10,000 EUR => Margin =1%=100 EUR =$130

0.01 lot = 1,000 EUR => Margin =1%=10 EUR =$13,02

Lot size = Max Investment / Margin

Lot size = $1,500 / $1,302 = 1.15 lots (round it to 1.1 lots)

How much pips you can afford to lose ? (Stop Loss)
First we need to find out the pip value.

1 pip = lot size x tick size
( for Direct rates as: EUR/USD, GBP/USD, AUD/USD, NZD/USD )

1 pip = pip = lot size x tick size / current rate
for Indirect rates as: USD/JPY, USD/CHF, USD/CAD )

1 pip = lot size x tick size x base quote / current rate
( for Cross rates as GBP/JPY, EUR/JPY, AUD/JPY, EUR/GBP, GBP/CHF - where USD is not involved )

Examples by using the standard formula:
EURUSD = 100,000 x 0.0001 = $10
USDCHF = 100,000 x 0.0001 = 10 CHF
USDJPY = 100,000 x 0.01 = 1000 JPY

Then use these results vs your account currency rate, to find the pip value into your account currency! (in our example in USD)

Or use instead the other 2 formulas and then denominate these $ results with your account currency vs USD rate.

E.q 1:

1 pip = lot size x tick size / current rate
for Indirect rates as: USD/JPY, USD/CHF, USD/CAD)

For a trade of 10,000 USDCHF (0.1 lots):
USDCHF = 0.9290

1 pip = 10,000 (lot size) x 0.0001 (tick size) /
0.9290 (current rate) = $ 1.07

1 pip = lot size x tick size x base quote / current rate
( for Cross rates as GBP/JPY, EUR/JPY, AUD/JPY, EUR/GBP, GBP/CHF

a trade of 10,000 EURJPY (0.1 lots):
EURJPY = 121.35 and EURUSD = 1.3060

1 pip = 10,000 (lot size) x 0.01 (tick size) x
1.3060 (EUR/USD base quote) / 121.35 (current rate) =  1.07 $

Now, let's get back to our practice example:
Pip Value for 1.0 lot = $10
Pip Value for 0.1 lot = $1
Pip Value for 0.01 lot = $0.1

If the max Risk/trade = 2% = $200 and the pip value = $10

SL = $200/$10 = 20p / 1.0 lots
SL = $200/$1 = 200p / 0.1 lots
SL = $200/$0.1 = 2000p / 0.01 lots

So, in this example you can trade 1.10 lots.  The SL= 20p at this volume.

But if you want to use need a higher SL level for a trade, while keeping the same Money Management Rules, you can use smaller lot size ( mini-lots/micro-lots).

If you want to open 3 trades with 0.1 mini-lots/trade:
200p/3= 66p/trade (for each one of these 3x0.1 lots trades)

If you want to open 5 trades with 0.01 micro-lots/trade:
2000p/5= 400p/trade
(for each one of these 5x0.01 lots trades)

But what if you found a potential trade and you know the SL level ?
How many lots can you use for that trade ? ( this will be the only one opened trade, until is closed)

Lets say the SL = 90p needed for that trade.
This is how you can calculate the lot size according to your Money Management Rules:

Lot Size = Risk Amount* (in $) / Number of Pips x Pip Value
Lot size = (Capital x Risk%) / (Stop Loss in Pips x Pip Value)
*After each trade calculate the Risk Amount again or at least 1 time/week

Lot size = $200/90p x $10= $200 / $900 = 0.22 lots (for this trade example)
Lot size = ($10,000 x 0.02)/(90p x $10) =
$200 / $900 = 0.22 lots = 2.2 mini-lots = 22 micro-lots
(when Actual Account Balance is different, than Initial - we must calculate again the Risk Amount)

Best Regards,

Personal Life Money Management as trader ( or the real "Holy Grail" in trading )

Being a trader ( full-time), you need to know that without a good Personal Life Money Management System, you can't trade profitable on a long run. Not even if you have a good strategy, a good MM Rules or even if you have a good Open Positions Management.

Let's start with the beginning. Why do you want to be a trader ?

Im sure many of us, started trading to get rich faster, more than "keeping" our economies. Being a trader, we thought we will have faster ( few years ), lots of money to buy houses, cars, expensive holidays, etc.

So the temptation was big. Still is. Think of this: you started to trade profitable, you quit your job ( or other income sources ) and reached $ 100,000 in the last 5 hard years.
How's your life improved with this money ? Would your life, still be the same with this big trading account ?

If you withdraw money from your account could be better. But if you do that ( or started to do that earlier, month by month ) you don't have the same big account for your main income source. And even if you still continue to earn money from trading, by withdrawing it each time for improving your life, you will never be a rich person...Not to mention that someday or from time to time, your trading is not working like it did before...and you "must" withdraw part of it, because you already saw something to buy...a new car...a new house or to pay an expensive holiday you always dream of.

We all know that having "goals" while trading will add negative emotions and will make us to take bad decisions while trading ( "today I have to make $ 1,000" or " by the end of the month I have to pay...$ 3,000 bills" or " by the end of the year I want to buy a new house " ). So we still do it. Is in our human nature to wish more or to dream of. And by doing this we forget the initial purpose of becoming traders: a beautiful and comfortable profession, working from home or in holidays using a laptop, never have employes or clients and earn more money that a regular job or profession. And in the end...becoming rich...and have a totally independent life.

So we must have a balance, an equilibrium. And this is so hard to get. And that's why this lack of patience of becoming a wealthy person while "living your life" and spoiling yourself with what you think you need, make most of the new traders to blow their accounts away. ( " If you buy things you don't need, soon you will sell things you need!" - Warren Buffett ).

The first "battle" is not won, when you started to become profitable, but when you trade and no matter if you earn money, or not,  you still keep your lifestyle! And that's the most important thing you should understand, when you want to become a trader and intend to remain "on the market"
( "Being a wealthy person equal the period of time of keeping the same lifestyle, without earning more money - R.T Kiyosaki )

Therefore, there are some good Personal Life MM Rules:

1). Don't start trading, with borrowed money. ( Use economies + investments income from your economies, only )
2). Don't start trading using money, you can't afford to lose.
3). Don't start trading if your life or your family life, depends on the profits unearned, yet. ( monthly goal )
4). Don't start trading with a $ goal in your head, like a "new car" ( "Trade what you see, only" )
5). Withdraw profits initially, only to deposit it in a bank. ( increase "backup money" ). You can keep it into your trading account, if is not tempting you to increase no of lots, without MM Rules.

Also, you must understand that in this profession, you either have initial money to start trading big ( when you are prepared ) or you have time to start it with a small amount and have patience ( years ) to end up "trading for living". If you start with less than $ 1,000, you need years to become full time trader. ( or you can live a cheap life until then - like being student and living with your parents ).

Just to have it in mind: a healthy profit / month = 10-15%. You can make more...or less. But don't expect 100% / month. If you like gambling ( or need it to become rich faster ), better go to a casino and use all your money on a single roulette number. You have more chances, mathematically, to win, than trading  Forex with a bad MM. You can have "luck" to trade profitably like this, few months, but you can't have luck each make $ 100,000 faster.

So how can you start trading ?

I can show you how I did it, after many loses that almost made me quit trading in my beginning years:

1). Build a strategy for trading. ( specific signals/confirmation for entry + exit rules )
2). Build the MM Rules according your strategy statistic ( SL, TP, lots, account's exposure %, account's % loss for stop trading )
3). Trade it on DEMO few months ( at least 3, ideal 6 months or better 1 year )
4). Remember profits on demo does not guarantee profits on a real account. ( different emotions )
5). Establish the amount of money you can afford to lose. ( economies )
6). Deposit 50% to bank ( backup money ) and 50% to a Forex account.
7). If you lose the established % from account balance, stop trading, go demo and don't come back to real trading until you found out, what went wrong ! Refill the account using the backup money and start over.
8). If you are profitable, don't double the no of lots until the account balance is doubled, as well ( or withdraw profits and deposit to bank account to increase backup money ).
9). If still in profit after 1 year, you can add 50% from backup money to you trading account to double or triple no of lots, using the same MM Rules and keep withdraw profits to bank deposit for building backup.
10). If still in profit after 2 years, you can fill your account with all backup money and you can upgrade your MM to the next level ( from 1% to 2% risk/trade and exposure from 15% to 30% ). Start again to build your backup money deposit, using monthly profits.

You think this is "too much" ? Yet, you go ( or went ) to school more than a decade plus 4-5 years in a college, to start a "normal" profession, followed by 2-4 years of practice ( doctors, engineers, IT programmers, architects, teachers, etc ). Why did you thought that becoming a trader is easy ? If this would be easy...then we'll all be rich and happy. Right ? :)

Still think you can start a trading account with less than $1,000 and in less than 1 year become full time trader ( "trading for living" )?

Good luck, then ! And send me an e-mail in 1 year, to tell me how you did it. Or better, build a website and let us all know about it ! Maybe there are few that done this, with less than $ 1,000 in less than 1 year...But what if you will be on the other 99% that risked all to achieve this in less than 1 year...

Best Regards,

Money Management ( or how to make money using any strategy )

Money Management ( MM ) is one of the most important thing you should know about trading, yet is not always on the front page of the courses, books, etc.

There are lots of ways of using MM in your favor. The problem for many traders, beginners or not, is how to stick to it.

Everyone knows the basics, yet, not everyone understand it: "Never risk more than 2% from your account (SL), never invest more than 30% from your account (opened positions)". For beginners, I would recommend risk = 1% / trade and max investment/trades = 10-15%. This will not make you rich fast, but will give you the change to grow constantly. ( MM for real accounts trading is completely different from MM for the contests accounts, where you must use a much higher exposure and a much higher risk to be in the top 10 traders - but still, you must stick to it, from the beginning to the end of the contest ). To find some MM examples, check Lesson #8 from my Free Course.

Trading is about chances. By opening any position, buy or sell, on any financial instrument, you have 50% to be right ( price can go up or down/swings, even if the swings might have same highs and same lows - range market ). Because of this, you need a strategy, that will increase your chances to be right. Here is the catch: many people think of it and search for the "holly grail" of trading. The problem is they never quit searching...and they become "testers" of all the possible strategies around the web, for this. ( sometimes their lack of patience for testing it on demo, makes them testing it on real account, when their initial strategy failed them ).

Finding a good strategy might take you time, but it's either you have time ( for testing on demo ), either you have money to lose, to find it, this way. Sometimes, you don't have time for testing and you don't have lose either.
And after first loses, you start to "search" a new strategy that might make you rich. That's one of the most common mistakes, that will make you blow, one account after another...

After my first 2-3 years, while searching and testing all possible strategies, around the web, I found out that is useless to search for a "better strategy" ( any mistake you will mention it to me, remember, "I've been there and I've done that!" - that's why taking bad choices = experience for me, now ). The secret is related to the MM and R:R Ratio ( TP = 3x SL, for example ), besides Opened Positions Management and Personal Life MM. ( articles to come ).

Let's have an example of good MM and a very bad strategy with only 3/10 trades in profit ( yes, a very very bad strategy ), using a TP = 3 x SL :

- 7 negative trades ( 7 SLs hit)
- 3 profitable trades ( 3 TPs hit )

Lets say your MM Rules allow you a SL = 30p, that means your TP must be at least 3 x SL = 90p.

- 7 negative trades ( 7 SLs hit ) = 7 trades x 30p loss = 210p loss.
- 3 profitable trades ( 3 TPs hit ) = 3 trades x 90p profit = 270p profit.
TOTAL: 10 trades ( 3 positive and 7 negative ones ) = 270p - 210p = + 60p in profit.

Can you imagine now a medium strategy with at least 7/10 in profit ? Can you imagine what means using it with strict MM Rules and a R:R 1/5 or 1/8 ( using harmonics and Positions MM, your TP could reach up to 20 x SL my moving your initial SL and your initial TP ).

Lets see the math behind using the same MM Rules example  with SL = 30p and TP = 3 x SL = 90p:

- 3 negative trades ( 3 SLs hit ) = 3 trades x 30p loss = 90p loss.
- 7 profitable trades ( 7 TPs hit ) = 7 trades x 90p profit = 630p profit.
TOTAL: 10 trades ( 7 positive and 3 negative ones ) = 630p - 90p =  + 540 in profit.

Hope now is clear for everyone, that your MM Rules must be nailed on your wall, on your monitor and what's most important, in your head. And if you trust your strategy and keep the same data for your MM, while trading it, you should be in profit.

But, do you trust your strategy ? Did you made the statistic yourself ? Or you just use this strategy because someone claim is 7/10 profitable ?

Considering other people statistic is not enough. I also like to use 100 trades not just 10. So my statistic, could be: 80/100 trades in profit, for example. Why ? Because I need to see it on a long run and because math behind must show me if the "chances" are proven facts. ( do the math: how many consecutive loses can be possible , until 1 trade will make the profits )

We all know, trading is about emotions. To control emotions, we need rules. And we must stick to it, no matter what. That's why a 7/10 strategy, that will give you 5 consecutive loses, make you stop trading it and start to use another one. But what if the math was right, and you will see it as 70/100 trades ? That means you must be there for 30 loses...why to stop using it after just...5 negative results, consecutive or not ?

Ofcourse you should use MM Rules and:

n1. You must know, your SL and TP.
2. If your account reach -30% from initial balance, you should stop trading and go demo again!
3. Don't come back to real, until you'll find out, what went wrong !
4. Refill your account ( you need back up money always - Personal Life MM )
5. Keep the same rules and increase your trading lots ONLY if your account is double !

So, if your limit of loses is 30%, that must be the bottom line. You just need a system that allow you as many possible consecutive loses. If your MM Rules allow you ONLY 10 possible loses until this limit, not even the best strategy in the world, can't offer you profits !!! ( or if you have profits 1 month, means you are just... lucky )

Best Regards,