Forex Money Management Styles
Money management in Forex is perhaps as critical as risk management. You must know it clearly in your mind how much money you can afford to lose without being affected. There are two widely adopted money management techniques.
Either you can take many frequent small stops while trying to get profits from the limited number of large winning trades, or you can opt for gaining small profits with infrequent but large stops with the anticipation that many small profits will overshadow few large losses.
These methods are to be adopted once you are fully aware of your nature and psychological strength. Risk management involves placing stop orders. There are four types of stops that are placed depending on specific situations.
The first type is Equity Stop, which is the simplest of all. In this a predetermined amount is risked in each trade. There is some thumb rule of risking 2% of entire investment. For example, in a trading account of $20,000 you can risk $400, or about 400 points on one mini lot (10,000 units) of EUR/USD, or only 40 points on a 100,000-unit standard lot. One may risk a maximum of 5% on equity stops if he or she is an aggressive trader. But you must remember that 10 consecutive losses may result a net loss of 50%.
There are two strong criticisms against this method of stop. The first, the exit point is placed solely on the basis of random parameter. The second, there is no logical support or market feedback that is followed by the trader. This goes against the basic nature of the Forex market.
The next type of stop is Chart Stop, which are generated by various methods of technical analysis. These are developed on the basis of technical indicator signals.
The third type is the Volatility Stop, which is an advanced version of chart stop. This employs market volatility as opposed to price action in setting the exits points. Depending on the market volatility, the trader formulates stop limit not to get stopped by intra-market noise. Bollinger bands work efficiently in measuring market volatility
The last type is Margin Stop, which is most rebel in nature. Judicious decision however makes it most effective among all the types. The stops are generated as soon as the placement of a margin call. This is possible as the forex market is open round the clock. The automated trading platforms are set accordingly so that the trader never faces the danger of having a negative balance in their account.
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