Beginner Forex traders often blame the market or unpredictable events for why they have come up with a loss. However, put an experienced trader in the exact same situation and dealing with the exact same currency pair, and the trader is likely to come up with a profit. The difference is that the experience Forex trader knows how to manage money. Unfortunately, money management habits are something which most Forex traders neglect.
The reason that money management is so important with Forex trading is because a small loss requires a larger gain in order to recoup. For example, if you lose 25% of your equity, you would need to gain 33% of your equity just to recoup the loss. If you lose 50% of your equity, then you would need to gain 100% of your equity just to recoup the loss! By the time you have lost 75% of your equity, you would need a 400% return in order to recoup your losses. Despite the reality of this situation, it is common for traders to ignore money management techniques and lose their entire Forex profits in a few bad trades.
The key to money management in Forex trading is going for the small, low-risk profits. But most novice traders (who will never have the chance to become experts!) are not trading in this way. Instead, they are hoping for that “Big One” in which they make a cool million off of a single Forex trade. It is easy to see how the beginner Forex traders get this idea in their head, especially when tales of traders like George Soros are filling their heads. While it is possible to make massive gains from a single, risky trade, it is much more likely that you are going to deplete your Forex account.
To avoid destroying your entire Forex account in just a few trades, you should never invest a large amount of your account in a single trade. Experts like Larry Hite recommend never putting more than 1% of your total account in one trade, though there are others who recommend as low as 0.5% up to 5%. At the same time, a Forex trader must have an exit plan for both losses and for gains. The psychology of forcing yourself to sell a currency which is still going up can be painful – especially after you see the price going up steadily after you sell. But, if you don’t sell, the currency is bound to come tumbling down and you would miss out on all the profits. Forex trading is a risk, no matter how smart you are about the markets. Only by using smart money management skills can you turn Forex trading from a risky gamble into a sensible investment.