LESSON 5: MONEY MANAGEMENT
Objectives:
If you take this lesson to the end, you will know:
1. How to determine your Risk.
2. How to determine your TP and SL levels.
3. How to carry out Back-Testing.
4. How to determine the success rate of indicators.
Money management
Money management refers to the set of principles and rules followed in order to protect your trading capital. It helps in the process of deciding your risk per trade. Implementing these rules protects your account from large losses.
Risk
Risk is the percentage of your account you can lose comfortably, if you must lose a trade. Advisably, only 2% of your account should be your risk.
That is, only 2% of your account on all trades. If you decide to take only one trade, the 2% should go on it. However, for two positions, go 1% on each position, and for four positions, go 0.5% on each position.
EXAMPLE
For a $500 account,
Risk = 2% of 500
= 2/100 x 500
= 0.02 x 500 = $10
What we do:
Our Risk is always 2%, so if we are to take only one trade, we put the 2% on it, 1% each for two trades, and 0.5% each for four trades. This is what you should do. Instead of 2% on each trade.
Always do this to avoid over trading and risking too much.
Stop-loss
The Stop-loss is a point (price) at which an opened position closes on its own to prevent further loss.
It can be determined by:
1.5ATR
For instance:
Let’s say the ATR of a pair you have entered is 82
Stop-loss = 1.5ATR
= 1.5 x 82 = 123
For a Long Trade, subtract 123 from the entry price, to get the stop-loss position.
For a Short Trade, add 123 to the entry price to get the stop-loss position.
That is,
For a Long Trade.
SL = 1.5ATR – Entry price
For a Short Trade.
SL = 1.5ATR + Entry
NB: To determine your stop loss, always use 1.5ATR instead of Risk-Reward Ratio.
Pip-Value
The PIP value refers to the monetary value of a PIP (Percentage In Point) in forex trading, which is the smallest price movement that a currency pair can make based on market convention.
To calculate the PIP value:
Divide the risk by 1.5ATR
That is,
Pip Value = Risk / 1.5ATR
For our $500 account, our Risk is $10. If the ATR of the Pair being Traded is 82
1.5 ATR = 123
Therefore:
Pip-value = 10/123
= 0.0813
= 0.10
Relationship between Pip Value and Lot Size
The pip value is directly related to the lot size being traded in the following ways:
Pip Value = One Pip / Exchange Rate x Lot Size
One Pip: This represents the value of a single pip in the currency pair you are trading. For most major currency pairs, one pip is typically 0.0001 or 0.01, depending on how the pair is quoted.
Exchange Rate: This is the current exchange rate for the currency pair you are trading.
Lot Size: This is the size of your trade in lots.
Example: let's say you are trading a mini lot (10,000 units) of EUR/USD, and the exchange rate is 1.1200. To calculate the pip value using the above formula, gives you:
Pip Value = 0.0001 / 1.1200 x 10,000
= $0.89
So, each pip movement in this trade is worth $0.89.
Take Profit
The take profit (TP) is the point (price) at which a winning trade closes on its own to save the stipulated profit. The take profit should be placed at the ATR of the pair.
That is:
TP = ATR.
To determine the TP level on your trade, use the formula:
For a Buy position:
TP = Entry + ATR
For a Sell position:
TP = Entry – ATR
For instance:
For a sell position on GBP/USD at 1.21600 and the ATR of the pair is 82 pips, you would calculate your take-profit level as follows:
1.21600 (entry price) - 0.0082 (82 pips) = 1.20718
So, your take-profit level would be at approximately 1.20718. This means that if the GBP/USD exchange rate reaches 1.20718, your trade will automatically close with a profit of 82 pips.
For a buy position on GBP/USD at 1.21600 and the ATR of the Pair is 82 pips, you would calculate your take-profit level as follows:
1.21600 (entry price) + 0.0082 (82 pips) = 1.22482
So, your take-profit level for your first profit would be at approximately 1.22482. This means that if the GBP/USD exchange rate reaches 1.22482, your buy trade will automatically close with a profit of 82 pips.
NB: To determine your Take Profit, always use the ATR value instead of Risk-Reward Ratio.
Key Points to Consider:
Risk Management is crucial for preserving your trading capital. Even if your strategy has a high win rate, poor risk management can lead to significant losses.
Set Realistic Risk Limits: Don’t risk more than you can afford to lose, be mindful of how much of your capital you're willing to put at risk.
Adjust Risk Based on Account Size: If your account grows, consider adjusting your risk per trade, but always ensure you’re within 2% in all.
How to Trade Profitably
Trading the Daily time frame with a good Trading System puts you in-charge of your time and guarantees success. To do this:
Start at about 30mins to the close of the daily candle.
Check for Trade Entries according to your system.
Record the ATR of the Pair.
Determine your Risk, Lot Size, Take Profit, and Stop Loss, as stated above.
Divide your risk by 2. Call it R2.
Determine your Pip-Value using R2.
Take two positions of the pair with pip-value as your lot.
Set your stop-loss properly on the two positions.
On one of the positions, set a take profit at the ATR of the Pair.
TP = Entry + ATR for a Buy position.
TP = Entry – ATR for a Sell position. Top of Form
Once the price reaches your TP, move the SL to the entry Price on the remaining position (Break-Even).
Wait for your exit indicator to tell you when to close the remaining position.
Trading Journal
A forex trading journal is a personal log or record where traders document their trades, strategies, and performance. It is a critical tool for improving your trading skills, tracking progress, identifying patterns, and learning from past mistakes and successes.
A trading journal can be physical (written on paper) or digital (using a spreadsheet, specialized software, or trading platforms). Regardless of the format, its purpose remains the same: to provide insights into your trading history, trading habits, decisions, and outcomes to improve future trades.
The Table below shows the components and arrangement of a Trading Journal.
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Currency Pair |
Long/short |
Pips
gain |
Pips
lost |
Screenshots |
comments |
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Feel free to ask questions in the comment, or send us a mail at morepipz@gmail.com
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