3 factors to consider for your money management plan

3 factors to consider for your money management plan

Trading Forex is one thing different from trading for a living. We may all trade Forex but not all of us will trade long enough to call it their career fortune. The reason for this difference is in our chances of surviving in the market. Get one point clear here: the market has seasons and cycles that may work well for all of us at one point but once a favorable season is over, every move becomes unpredictable and the risk of losing trades goes up. This is where real traders are separated from opportunist and only the fittest will survive.

Your chances of surviving throughout all seasons of the market depend with your money management plan. Here there are three factors at play namely: Exposure, success rate and return on investment ratio. Each of these factors is well explained here:

Exposure

This is the amount of money from your account margin that you let to hold a trade position in the market. Your exposure, better expressed in percentage, should never be more than 1% for any given single position on the market. This figure should be even smaller if you are less experienced in trading Forex. However, each trader is unique and has a different risk appetite as some traders are highly tolerant to risk and others are very risk averse.

Success rate

Your success rate is an expression of how many trades go positive against those that lose in a given set of trades. By default, the upper limit for the trade is 100, which is then split between winner trades and those that lose. For instance if you place 100 trades over a period of six months and you lost 60 trades while winning 40 trades your success rate 40%. One gets to know their success rate after a number of trades over time, normally during their practice and learning period.

Return on investment ratio

This figure reflects on how much you win from what you expose out of your account margin. Return on Investment Ratio is expressed in ratio, for instance, 2:1. In such a case the trader will expose only 1 in anticipation of getting 2 in return. You actually do not need to have a higher return on investment ratio as even the most profitable trader have a maximum of 3 as their regular return.

Here is how to integrate all three factors at play: Hypothetical elaboration

To start with, you have a deposit of exactly $100 as your margin. You have an exposure of 1% and your return on investment ratio is 2:1at a success rate of 40%. If you complete a set of 100 trades and in the worst scenario you started with a streak of 60 losses you will have lost a total of $33.10 expressed as 33.10% of your initial account margin for each lost trade takes out 1% of the previous account balance. If a winning streak takes over from here you will have started with $66.90 which is left of your margin and by the end of the winning streak of 40 trades you will have an account margin of $147.72 from the initial deposit of $100 margin balance, which is a total of 47.72% net profit.

On the other hand, if the winning and losing trades were mixed up randomly the winner trades would still have carried the day. This hypothetical elaboration of how Exposure, Success Rate and Return on Investment Ratio can be employed clearly proves you do not necessarily need higher figures since in the end the compounded profits are greater than compounded losses.

However, you have to keep your winning scores high and never adjust your stop loss to allow more than the 1% exposure of your account balance. At the same time, you should target trades with the highest probability so you can attain the double return ratio.

Stick to the rule of thumb, ‘Take on the high probability trades and stick to the 1% margin exposure’.

Categories: Tutorials

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