A Basic Forex Money Management and Risk Management Strategy

Forex trading is a rollercoaster, isn't it? You're flying high for a minute, and then the market turns on you and you're just trying to keep your head above water. But this is the thing—money management and risk management can be what makes you different from riding the wave and getting decimated.

So, are you interested in talking about a simple approach that will get you started and keep your capital safe, whether you're a beginner or already a seasoned trader? Ready? Go ahead.

First Thing's First: Understanding Risk

Now let us not get too far along in life with this. We have to talk about the big bad wolf of Forex—risk. It's always hanging around. And then there's the leverage factor when you can purchase a much larger position than you could ever dream of, which is good if the market is going in your favor but a bad thing if it isn't.

Without risk management, you're basically crossing your fingers and hoping that the market will turn in your direction. And let's be realistic here, that is not a strategy that is going to pan out. You need to have a plan to protect yourself.

Step 1: Know How Much You're Willing to Lose

I get it, it’s tough to think about losing money. But in reality, knowing how much you’re willing to lose on each trade is key. A good rule of thumb is to risk no more than 2% of your account balance per trade.

For example, if you have $5,000 in your trading account, you will risk 2%, or $100 per trade. Regardless of how many trades you are ready to take, this will have you covered if the trade doesn't work as you've planned.

Step 2: Decide Your Position Size

OK, so now you know what you're willing to sacrifice. And then there's the position sizing—it is essentially determining the trade size to risk.

Assuming you are trading a currency pair, and your stop loss is 50 pips from entry. And you have $100 to risk, you will want to adjust the size of your position so that 50 pips will be worth $100. It is a way of risk management without holding you back from taking a trade that you think is good.

Step 3: Always, Always Use a Stop-Loss

There is no exit. Your stop-loss is your exit. A stop-loss exits you out of a position when the market goes against you by some extent you specify. You'll never hopefully ever require it, yet it will get you out of a losing trade when the item gets away from you.

How far ahead you place your stop-loss will also be determined by how volatile the market is, but don't make it so far ahead that you're losing too much. Don't risk the entire account, okay?

Step 4: Take Profits When You Can

I get it, I get it—you don't want to leave money on the table. But the problem is: greed is a lousy strategy. Markets turn on a dime, and if you're so focused on extracting every last pip from a trade that you're not disciplined, you'll be sitting there and watching your profits disappear.

One of the greatest ways to do that is to target a 2:1 risk-to-reward ratio. That is, you're risking $1 in order to try and make $2. If you risk $100, your profit target must be $200. You will still be profitable even if you are not always right in a trade when you have a ratio like that.

Step 5: Stick to the Plan (and Stay Consistent)

This is where the majority of traders lose. They become attached to a trade, or rather fall in love with a loss, and start changing the plan in a trade. But persistence is the game.

No trader will ever win all the time. You can't have a perfect win record. But if your winners are greater than your losers, and you're trading the system, you'll be a winner in the long run.

The Bottom Line: Don't Let Emotions Take Over

Trading becomes emotional, guys. Some days you're on top of the world and can't be hurt. Other days it seems like the market is out to get you. Don't trade emotionally. That's what your risk management plan is for—to reel you back in when you get out of hand.

Finally, Forex trading is a marathon and not a sprint. You don't have to win every trade, but you do have to save your capital and make sound decisions in the process.

So just relax, have faith in your strategy, and let the market do its thing. You've got this.