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Protect your money today so you can trade again tomorrow, by minimizing your losses and maximizing your profits.
Although no one likes to loose money, every one has a different tolerance for how much they are prepared to loose. Many approach trading with a gambling mentality, and fail due to their lack of skills. We believe that the defining characteristics of those who succeed are discipline, patience and confidence. You cultivate discipline and patience by investing your time in developing effective money management skills and implementing them consistently. When you employ these skills and begin to repeatedly incur net profits that are higher than your net losses, you are simultaneously building your confidence. In our opinion, identifying trading opportunities in the foreign exchange market is subject to many money management myths. Here we discuss two of the more common ones.
Myth: You can be on the wrong side of the trade 50% of the time and still make money if your stop losses are smaller than your targeted profit.
Fact: For many trading styles, it is wise to set stop losses at least 30-40 pips outside of an identified support or resistance level. The foreign exchange market is range bound the majority of the time. Currency day traders frequently aim to make 30 to 40 pips in a day. The difference between their entry point and their stop loss can easily reach 60 + pips. In order for their losses to be smaller than their targeted profit amount, they would have to decrease their stop loss and risk getting stopped out of their trade. Placing improper stop loss targets is one of the most costly mistakes made by uninformed traders. Profitable traders regardless of their trading style (scalper, day trader, swing or long term trader) rely on their ability to identify support and resistance levels and set stop losses accordingly.
Chart: A *
Chart: B *
Chart A clearly indicates that the USD/JPY currency pair is trending down. Once this is established a day trader will be looking for a high point to sell into. A double top on a 15 minute chart in a down trend frequently triggers a continuation of the down trend.
By studying the USD/JPY in Chart B we can see the double top did not follow through with the down trend before turning up and challenging the previous high. The high on the double top reached 110.58 and the low reached 110.26. It is unrealistic to expect to get the highest high as an entry point. Let’s assume that a sell order is placed at 110.43. Seasoned traders would place their stop loss above the previous high and protect their trade against unforeseen spikes like the one that followed the double top.
On the far left we can see resistance forming at a high of 110.77 before turning downward. If our entry point is at 110.43 and our stop loss is at 110.63, our exposure is only 20 pips. However, we would have been stopped out of the trade and lost 20 pips. With a stop loss set at 111.07 (30 pips above the identified resistance point of 110.77) our exposure is 64 pips. In this case we would still be in the trade and making money. This pair forms a bottom after reaching a low of 109.11. It is unrealistic to expect to get the lowest low as an exit point.
Let’s assume that we exit the trade at 109.41.
| Entry Exit Profit |
110.43 109.41 102 pips |
Mini account: trading with one lot ($100.00) = $102.00 Standard account: trading with one lot ($1000.00) = $1020.00 |
To learn more about mini & standard accounts please see our Foreign Exchange section
Myth: There is nothing wrong with taking profits regardless of how small they may be. You may also hear: You can’t lose by taking profits.
Fact: Maximizing trading opportunities is an integral part of forex trading. It is very difficult to make up for bad trades, if a trader cannot allow a good trade to run its course. If the profits you are incurring are less than your losses, how can you become profitable? Recognizing tops and bottoms and their relative strength is imperative.
Chart: C *
Chart C Shows the results that followed after a bottom was formed in Chart B.
A buy order as high as 109.85 with a sell order (exit) as low as 111.25 would result in a 140 pip gain. The far right in Chart C indicates another bottom that will challenge the top.
The rules and guidelines outlined below serve as a good example of how money management can help you take advantage of forex trading, seek to control your losses, and build your confidence. We are using a very conservative approach in our examples relative to the trading opportunities that the currency market can present. We are using the smallest trade lot size in both the mini and standard account as a starting point. It is not important for you to start there, but it is crucial that you learn how to protect your initial investment and build capital.
1. Do not MULTI TASK when trading.
2. Predetermine the most you are prepared to lose on any one trade given the type of trade you are making. General rule of thumb: A short-term trade should reflect a smaller risk and reward. A long-term trade should reflect a bigger risk and reward. (Scalping: in and out within seconds or minutes; Day trade: in and out the same day; Swing trade: in for more than a day and up to a couple of weeks; Position trade: long term, weeks, months…)
3. Identify support and resistance points before you enter a trade to help you set stop losses and lock in potential profits
4. Evaluate the risk/reward factor of each trade
5. With the exception of scalpers, we advise traders to set stop losses a minimum of 30 pips outside the support or resistance level.
6. Do not increase your predetermined stop loss if the trade goes against you.
7. Identify potential targets and set limit orders to lock in profits and limit your exposure.
8. Use trailing stops to lock in profits.
9. Do not deviate from your trading plan. The method and plan you use to trade in your demo account should be exactly the same as your real account.
10. Learn to identify the signs of a possible trend reversal through our daily analysis to avoid getting out of a profitable trade to early.
11. Do not increase the number of lots you are trading with “to make up for a loss.”
12. Decide how much capital you want to trade with in your account and take the excess to pay yourself regularly. Avoiding this guideline can lead to negligent trading which in turn can lead to higher losses.
13. If you lose three trades in a row, thoroughly review your trading methodology and go back to trading with a smaller lot size.
14. When trading with multiple lots invest your money in thirds. Only add lots to profitable trades.
15. Do not allow for losses to exceed more than 1/3 of your trading account.
Swing Trade (Day trades frequently turn into swing trades if you let your profits run.) When you learn to recognize significant support and resistance points being protected during your trading session you can benefit from a longer term trade.
Hypothetical example #1: 10 Trades, Mini Account
Day Trader/Swing Trader: Looking for 30+ pips
80 pip maximum stop loss tolerance
Initial Capital: $1500.000
Preferred currency GBP/USD
Trading with one lot ($100.00) in a mini account
Each pip is worth $1.00, therefore 80 pips are worth $80.00 and 200 pips are worth $200.00
| 4 Losing Trades | 6 Winning Trades | |
| 50 pips = $50.00 | 30 pips = $30.00 | |
| 80 pips = $80.00 | 70 pips = $70.00 | |
| 60 pips = $60.00 | 90 pips = $90.00 | |
| 70 pips = $70.00 | 200 pips = $200.00 | |
| 180 pips = $180.00 | ||
| 40 pips = $40.00 | ||
| Net Loss = $260 | Profit = $610.00 | |
| Net Gain $350.00 | ||
Before you move to the next numerical increment in lot size, we recommend that the value of your account can absorb 3 consecutive bad trades without affecting your original capital and approximately half of your profit. Note that your winnings will double when trading with two lots but so will your losses. In this example $2400.00 would provide you with the necessary cushion.
At any point in time, if you find yourself on the wrong side of the trade 3 times in a row, we strongly recommend you go back to trading with the previous lower lot size until you get back up to your target. The target amount you protect should increase as the value of your account increases. This is infinitely important to your trading confidence.
Hypothetical example #2: 10 Trades, Mini Account
Day Trader/Swing Trader: Looking for 30+ pips
80 pip maximum stop loss tolerance
Account Balance $2400.000
Preferred currency GBP/USD
Trading with two lots ($200.00) in a mini account
Each pip is worth $2.00, therefore 80 pips are worth $160.00 and 200 pips are worth $400.00
| 4 Losing Trades | 6 Winning Trades | |
| 50 pips = $100.00 | 30 pips = $60.00 | |
| 80 pips = $160.00 | 70 pips = $140.00 | |
| 60 pips = $120.00 | 90 pips = $180.00 | |
| 70 pips = $140.00 | 200 pips = $400.00 | |
| 180 pips = $360.00 | ||
| 40 pips = $80.00 | ||
| Net Loss = $520.00 | Profit = $1220.00 | |
| Net Gain $700.00 | ||
Hypothetical example # 3: 10 Trades, Standard Account
Day Trader/Swing Trader: Looking for 30+ pips
80 pip maximum stop loss tolerance
Initial Capital $7000.00
Preferred currency GBP/USD
Trading with one lot ($1000.00) in a standard account
Each pip is worth $10.00, therefore 80 pips are worth $800.00 and 200 pips are worth $2000.00
| 4 Losing Trades | 6 Winning Trades | |
| 50 pips = $500.00 | 30 pips = $300.00 | |
| 80 pips = $800.00 | 70 pips = $700.00 | |
| 60 pips = $600.00 | 90 pips = $900.00 | |
| 70 pips = $700.00 | 200 pips = $200.00 | |
| 180 pips = $180.00 | ||
| 40 pips = $400.00 | ||
| Net Loss = $2600.00 | Profit = $6100.00 | |
| Net Gain $3500.00 |
Hypothetical example # 4: 10 Trades, Standard Account
Day Trader/Swing Trader: Looking for 30+ pips
80 pip maximum stop loss tolerance
Account Balance: $15000.00
Preferred currency GBP/USD
Trading with two lots ($2000.00) in a standard account
Each pip is worth $20.00, therefore 80 pips are worth $1600.00 and 200 pips are worth $4000.00
| 4 Losing Trades | 6 Winning Trades | |
| 50 pips = $1000.00 | 30 pips = $600.00 | |
| 80 pips = $1600.00 | 70 pips = $1400.00 | |
| 60 pips = $1200.00 | 90 pips = $1800.00 | |
| 70 pips = $1400.00 | 200 pips = $4000.00 | |
| 180 pips = $3600.00 | ||
| 40 pips = $800.00 | ||
| Net Loss = $5200.00 | Profit = $12,200.00 | |
| Net Gain $7,000.00 |
Methods and denominations will vary. The objective is constant; to minimize losses and maximize profits. By setting stop losses consistenly 30 - 40 pips outside of support and resistance points and predetermining your risk on every trade, your losses are capped every time regardless of how far the trade goes against you. Recognizing significant tops and bottoms allows you to take advantage of trading opportunities. In summary this method of managing your money while seeking to let your winners run, aims to help limit your losses.
Examine graphs A to C carefully. They effectively illustrate how the GBP/USD’s upward trend reverses. Traders have an opportunity to enter a sell trade and cover a 30 -40 pip stop loss, risking 80 pips in total. The amount risked could have modestly yielded double the return in profits.
Chart: A *
Chart: B *
Chart: C *
This 15 minute chart shows several entry points for a day trader to take advantage of, before the potential of a trend reversal is seen at the bottom of chart B. The down trend was triggered on the 13 of September. The potential for a trend reversal is not seen until late into September 17 and early morning on the 18th. A day trade could have easily turned into a swing trade.
* Hypothetical performance results have many inherent limitations. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particularly trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk. Variables such as the ability to adhere to a particular trading program in spite of trading losses as well as maintaining adequate liquidity are material points which can adversely affect actual real trading results.
