Clarifying the 5% Money Management Rule
One of the key components of Money Management is the 5% rule. That is, never put more than 5% of the trading account at risk at any one time. The rationale behind this is that when we have losses (and we WILL have losses, make no mistake about that) they will be small and manageable as opposed to large and catastrophic.
Oftentimes however, this rule is erroneously interpreted as meaning 5% per trade. This is not accurate.
The 5% rule pertains to the TOTAL amount of the account balance at risk at any one time…NOT on any individual trade. So, if you have one trade open, 5% is the maximum allowable risk. If you have two trades open or five trades open or ten trades open, the maximum that could be lost if the stops on all of the trades triggered at the same time is 5%.
Think of it this way, if the rule were 5% pertrade, a trader could open five trades risking 5% on each trade and still be within the rules. What would prevent a trader from opening up ten trades and only risking 5% on each one?
There has to be something that prevents the trader from over leveraging their account and that something is the “5% risk at any one time” part of the rule. Otherwise, as you can see from the previous 5% per trade example, the trader with five trades with 5% account risk on each one would have 25% of their account at risk and the trader with ten trades would have had 50% of their account at risk.
Clearly, neither of those would be a situation in which a prudent trader would want to find themselves.
Many of us have different thinking ideas for successful trading but how many or are actually effective for success? All of us traders need to know what good trading or successful trading depends on. When you want to be a successful trader you will discover all those doors one by one. It is normal for the market to go against you again and again or in your favor, but in the opposite situation you have to be successful by applying your strategy, that is why you will be considered as a successful trader. So let's know what things will help you in a successful trade. Analysis: (Analysis will be before each of your trades) First of all you have to do this work. You need to choose a currency pair that indicates a clear market condition and has a good chance of making a profit. You need to adjust the trading method and the risk ratio of each trade through proper analysis. Sometimes you have to move slowly from the position where you will trade in a single currency, otherwise, you will be forced to trade in a difficult situation. Understand the type of analysis and select specific indicator tools. Order: When you choose the right currency pair and the right movement, your trading system will change a bit, but you have no reason to worry, you will be in favor of the market and will be able to take profit. The thing to worry about is when you open a trade without any analysis and you are worried about the market movement, exactly what to do at the moment. In the case of orders that cannot be mistaken, e.g. # Trying to understand market movement clearly with many indicators. # Trading based on indicators only. # Not resorting to any method in case of trade open. Money Management: Almost all traders are aware of money management but very few traders take advantage of it. Without being too complicated, think about the size of your next trade and whether it is capable of your current balance. Some issues need to be left out of the head, such as money management issues, # My account needs small money management. # I have my own trading method in my head so I don't need any other method. Risk Management: The focus of traders is to open the right trades just as it is important to close the trades that come out of the trades at the right time. Risk management will help you determine exactly where your stop will be and where the profit point should be. There are more things to follow in risk management: # Increasing the stop or profit by moving away from the strategy by predicting the trend. #Or move away from the original strategy with partial profits. Trading Psychology: This point is a little more sensitive and complex. Basically, the psychological issue plays a very important role in trading. Which, of course, made the video an overnight sensation. So for good trading, you need to be as systematic as you need to be mentally prepared. So trade well with the right benefits of the above. Thanks;
Student’s Question:In the Range Trading Webinar, a multiple lot strategy is mentioned where one lot can be closed to lock in profit while the other lot can be left open for the potential of a greater gain. Could you show how that would work with a chart?Appreciate it.Instructor’s Response:Good question……Take a look at the chart below…… In a range we want to buy at support. So at the green support zone, we would buy two (multiple) lots and set our stop at the level of the yellow line below the lowest wick that penetrated support.Then, at approximately half way through the range, we would close out (sell) one of the lots, thereby locking in that amount of profit and move the stop to breakeven on the remaining lot.We would then let the remaining second lot trade up to resistance (the top of the range) and close it out at that level or just before. That would be the ideal scenario. However, if the trade does not make to the top of the range and simply retraces all the way back down to support, we would be stopped out with a breakeven stop…in other words, no loss/no gain. But we would still have the profit from closing out the first position at the halfway point.This strategy allows a trader to lock in at least a moderate level of profit (assuming of course that the trade has moved in their favor to a certain degree) even if the trade does not make it all the way to the desired target level or limit.
Forex Hedging was one of the main drivers behind the explosive growth of the FX markets that gathered momentum the early 1980s. Foreign Exchange controls which had restricted the movement of capital were abandoned in the UK in 1979. As a result companies could mitigate their FX exposure and were able to plan for the future and price their products accordingly. For example if you were an exporter of fine china, with customers in the USA and sales in US Dollars but your overheads were in Sterling. Then you might wish to exchange your income in Dollars for Sterling on a regular basis, to avoid unnecessary currency exposure. Equally a UK company that imported machine tools from Japan may have wished to sell Sterling to buy Yen periodically, in order to fix its costs. With free access to the currency markets companies were able to expand overseas. Furthermore they could raise finance internationally, from wherever capital was cheapest. For example borrowing money in US dollars and then converting and using those funds to build a factory or warehouse in France. Free movement of capital and access to Foreign Exchange (or FX if you prefer) were the precursors to globalisation. Which for better or worse has and continues to shape the modern world. Increasing use As access to Foreign Exchange and overseas trade became more commonplace companies became more sophisticated in their requirements. Management could decide to take a view on their overseas sales and costs at the start of the year. And at the same time look at what they felt was likely to happen to relevant FX rates, over say the next 12 months. If they believed that these rates would move against them. Then they could “hedge” their exposure by selling or buying the appropriate currencies. They could also adjust their Forex Hedging throughout the year if their forecasts proved to be incorrect. Forex Hedging for traders Just as the speculative Forex markets developed from the corporate market so the practise of Forex Hedging moved from the corporate world into the world of Margin FX. For example if you are investor with overseas share holdings, you may wish to protect their value through a Forex Hedge. Lets imagine that you anticipate the value of those investments will rise near term, whilst the currency they are denominated in is expected to fall against your base or domestic currency. If the price of these investments rose by 5% over the next month but at the same time the currency they are denominated in declined by the same amount, against your base currency. You would realise little or no return. However if you used Forex Hedging and sold the investments underlying currency (in the same size as the underlying investments value) subsequently buying it back after the drop, then you would benefit from the nominal rise in the underlying investments value. What’s more in this instance you would have realised a profit without having to sell the original investment. Of course if your intuition about the currency is wrong and in particular if it appreciates versus your base currency, rather than depreciating, then the use of Forex Hedging could start to work against you. At that point you may choose to take off the Hedge by buying the short (sale) position back. Given the 24 hour a day 5 days a week nature of the FX markets closing your Forex Hedging positions should be very straightforward. What’s more using non deliverable margin trading to facilitate your Forex Hedging means you can benefit from the use of leverage and low deposits. Though always bear in mind that leverage works both ways. That is it amplifies profits and losses in equal measure and therefore that you could lose more money than you have placed on account. Diversifying Risk It also possible to use Forex Hedging to protect or diversify a portfolio of FX positions.More than almost any other group of financial assets FX pairs and crosses share correlations. These correlations come about as a result of their underlying relationship with their peers and the US dollar. To which all currency prices are ultimately re-based to, or calculated from. That said these correlations are not uniform and they can be either positive or negative, strong or weak in nature and they can and do vary in strength and direction over time. A spread of FX positions in different currency pairs may on the face of it appear to offer diversified exposure and to be spreading an investor’s risk. However if the positions in question are in the same direction and they all share some degree of positive correlation (that is a relationship where a change in the price of one will result in a price change in the same direction in the other positions), then they are offering anything but this. Instead of diversifying exposure they are likely to be concentrating risk. However the investor can use Forex Hedging to open a position in the opposite direction, in a negatively correlated instrument, which should move in the opposite direction to the other positions in the portfolio and which therefore offers diversification and acts as a Forex Hedge. Sterilise Positions Traders can also sterilise some or all of their exposure via Forex Hedging.They can do this by taking an equal and opposite position to an open position on their account. So for example if they are long GBP USD and wish to remain in that position but are unable to monitor the price (if they are flying for example) then they may choose to open a short GBP USD position, in the same size. The P&L of this position will move in the opposite direction to the long position and will act as a hedge to the downside. Though it will also negate any additional upside in the original position. One of the benefits of this type of Forex Hedging is that it reduces the Trader’s margin requirements, in some cases to zero, for the sterilised positions. A powerful and useful tool The ability for companies to Hedge Forex exposure has been one of the main drivers of global growth. In turn this has helped to break down trade barriers and bring millions of people from the emerging economies into the global marketplace. This has therefore been of one of the biggest agents for change over the last 50 years. Forex Hedging forms an important part of a trader’s toolbox, particular when they are looking to diversify their exposure or protect the value of investments held elsewhere, in a currency other than their domestic or base currency. Indeed sophisticated investors may even use Forex Hedging for asset allocation purposes. For example if they wish to quickly gain broad brush US Dollar exposure after some key data is released. Understanding when to use Forex Hedging comes with experience of the markets. But even those new to trading can experiment with the practice by simply opening forex trading account and downloading the Blackwell Trader MT4 platform for their desktop PC or mobile device (iOS or Android).