Money Management: The Secret to Success in Forex Trading 0 comments

Aug 24, 2009 9:09 AM

By: Hillel Fuld

The foreign exchange market is unique in many ways. It is the largest market in the world with close to 3 trillion dollars daily. It is quite possibly the least regulated market as well, with anybody able to open a Forex position from the comfort of their own home or even on their mobile phone. It also enables individuals with very little capital to trade tremendous sums of money with the high leverage offered in the Forex market.

Another highly unique characteristic of Forex trading is that there is money to be made irrelevant of the state of the market. How is that possible? As opposed to other markets, traders can benefit from a currency going up or down. It is important to remember that while the stock market is essentially one sided, and if your stock decreases in value, you lose money, Forex is a two way street. Just like you can sell a currency at a high price and benefit from its increase in value, you can also buy a currency after its value has decreased and watch it closely while it makes you money.

This is of course a very attractive quality in todays shaky economy. While other markets are suffering major consequences of the recession, the Forex market has not slowed down a bit, it is actually flourishing. This is yet another reason that the Forex market remains the largest market on the globe, by far.

These are all very important characteristics of the Forex market, but in this article, I would like to focus on something completely different, Forex money management. It would be interesting to conduct the following experiment. Have two non experienced Forex traders open opposite positions on the same currency; one will buy the EUR/USD while the other would sell. At the same time, have two experienced traders do the exact same thing. What would you expect to be the result of such an initiative?

The logical outcome of such a scenario would be that one side of each pair would profit, while the other would lose. If the USD would increase in value, the individuals who bought the USD would profit while those that sold it would lose. The issue of the traders experience might be irrelevant in such a scenario, after all, the USD does not care if the trader is an expert or a beginner.

This, as I expect, would not be the outcome of such an experiment. I am suggesting that the two beginner traders would both lose in the long run, while both experienced traders would profit. The obvious question is Given that these traders are taking two opposite sides of a trade, how is it possible that they will both profit or lose? As strange as this might sound, this phenomenon can be explained in two simple words: Money management.

It is true that in the short term, the two beginners and the two experts are trading against each other and one will profit, while the other will lose. However, in the long term, the beginner, who is new to the market, and does not know how to efficiently manager his/her account and trades, will end up losing the initial profit they made. The experienced trader, on the other hand, might lose in the short term, but with the use of Stop Losses, will make the money back and turn over some nice profits. Forex trading without money management can be a very dangerous endeavor. To illustrate this point, take a look at the below table that explains just how risky Forex trading can be.

Amount of Equity Lost

Amount of Profit Necessary to Return to Original State