Are you losing money in the forex market and you wanted to find out what you are doing wrong? Or do you just want to get ahead of the game and learn how to lose how to not lose money? Good, so now that you have made the choice to stop losing money in trades, now is an important time to discuss what you are doing wrong. The fact is, a lot of people losing money trading without regard to how intelligent or knowledgeable they actually are of trading, markets, etc.- losing money is not a matter of being smart or not, it’s actually applying some smart moves into your trades and methods. There is a common series of mistakes that many traders make that end up being the bane of their losses- it is not a matter of the market not having enough room for many to profit. Using a solid risk management technique can flip the script and get you back in the black before you know it.
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Use at least a 1:2 Risk to Reward Ratio
Last fall, DailyFX published their Traits of Successful Traders. We went through extensive research on the behaviors why most traders lose. Most traders lose money simply because they do not understand or adhere to good money management practices.
Part of money management is essentially determining your risk before placing a trade. Without a sense of money management, many traders hold on to losing positions far too long, but take profits on winning positions prematurely. The result is a seemingly paradoxical scenario that in reality is all too common: the trader ends up having more winning trades than losing trades, but still loses money.
To resolve this paradox, establish your risk and reward parameters ahead of time. Insist on taking trades that offer at least a 1:2 risk to reward ratio. This means that for every pip of risk you are taking in the trade, seek out at least 2 pips of potential reward. By doing so, you are relieving the pressure from yourself to have to be right in the trade.
As James Stanley eloquently points out in his trading plan, you can be right only 50% of the time when using a 1:2 risk to reward ratio to give yourself a shot at consistent returns.
Risk no more than 5%
However, there is another element to consistent risk management. How much of your account are you risking?
Too often, I hear from clients via twitter or during our live webinars that they are risking a small amount, just 20 pips on the trade. However, the true risk on the trade is how much of your account balance are you exposing?
Is it possible that Trader A can have a stop loss set at 10 pips and risk more than Trader B with a 50 pip stop loss? Yes!
In our courses, we suggest risking no more than 5% of your account balance on all open trades. That way, if you are wrong (and we established from the first key point that it is ok to be wrong 50% of the time), then you still have over 95% of your account balance available to trade tomorrow.
The formula to calculate risk on the trade is:
Cost per pip X pip’s risked = Account Balance Risked
For example, if I’m trading the AUDJPY with a current pip cost of $1.25 per 10k position, then a trade with 50 pips of risk is $62.50 risked in my account.
[ $1.25 X 50 pips = $62.50 ]
There are two basic techniques that this article covers:
• Risk a little to make a lot – use at least a 1:2 risk to reward ratio
An important part of money management is evaluating and determining your risk ahead of the trades you make. If you lack a solid sense of money management, you are likely to hold on to positions that are losing for much longer than you should- this is a mistake of many traders. Another mistake is cashing in on profits sooner than you should and missing future gains. It is entirely possible to have more winning trades than losing ones and still lose money- it’s actually quite common!
• Risk a small portion of your account – risk less than 5% of your account on all open trades
The rule of thumb is to risk no more than 5% of the total of all of your open accounts. This way, if you make a mistake and turn out to be wrong about your predictions, you still have 95% of your original funds. It’s important to make sure you have the capital to stay in the game and not put all of your eggs in one basket!
Watch this video about how to stop losing…
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