While the question of money management may seem fairly straightforward, it remains the most critical component of any trading plan.
Before placing a trade, traders should examine exactly what the risks
associated with that trade. This includes asking some tough questions
about stop placements, risk totals, as well as risk reward levels. To
help answer some of these concerns today we will tackle some tips for
better risk management. Let’s get started!
Plan Your Exit
More often than not, traders have an idea of where
to exit the market when a trade is moving in their favor. While a profit
target is always good to have, every trader should have a contingency
for when a trade moves against them. Stop losses can be set in a variety
of manners, but more often than not these levels are coupled with an
existing value of support and resistance.
Remember, a stop order is a point on the graph
where your trade idea is considered no longer valid. If you have buy
orders in place, and a key level of support is broken with price making a
lower low it may be time to consider exiting the trade. As well, the
opposite is true in a downtrend. If a trader is selling while prices are
making higher highs it may be time to look for a new trading idea!
The 1% Rule
After you have planned a point of exit, traders need
to decide how much to risk per trade. Since it is inevitable that at
one point a trade will close at a loss, it is important to know exactly
how much you intend to lose prior to that occurring. One way to
determine this is the 1% rule. Simply put, this means traders should
risk no more than 1% of their TOTAL balance on any one trade idea. For
instance if you have a $10,000 balance at no point would you want to
risk more than $100 on any 1 trading idea.
The 1% rule can also be coupled with a favorable
risk reward ratio. Using a 1:2 setting, this means if we risk 1% in the
event of a loss, at minimum we should look to close our trades out for a
2% profit. This would translate into a $200 profit on a $10,000 account
balance. Now that you are familiar with the 1% rule, let’s look at our
next risk management tip.
FXCM Money Management App
To help traders control and manage their risk,
programmers at FXCM have created a simple indicator to help decipher how
much risk is being assumed on any one particular trade. Once added to
Marketscope 2.0, the FXCM Risk Calculator, as depicted above, has the
ability to help a trader calculate risk based off of trade size and stop
levels.
We walk through the application, as well as how to
manage risk in several videos embedded into the brainshark medium. After
clicking on the link below, you’ll be asked to input information into
the ‘Guestbook,’ after which you’ll be met with a series of risk
management videos along with download instructions for the application.
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