One of the reasons that we stress good Money Management principles at FXCM is that as a trading account goes more and more negative, the challenge of getting out of the “hole” and back to even is quite daunting. Keep in mind that we are not talking about the normal manageable (5% or less) losses that take place simply as a part of trading. We are talking about losses that exceed 25%, 50% or more of the account size.
As you may have guessed already, the best way not to have to deal with this challenge is not to have the account go severely negative in the first place.
Take a look at the grid below…
Using the above figures, let’s say a trader has a $10,000 trading account and they lose 25% of it or $2500. The account balance is now at $7500 ($10,000 - $2500). To bring the account back to $10,000 they need to profit $2500. However, $2500 now represents 33% of the current account size of $7500.
So even though the trader lost 25% they need to grow the existing account size by 33%. As can be seen on the grid, as greater percentages are lost, the percentages needed to restore the original equity increase exponentially. These percentages can be overwhelming to both the account and the trader.
So, what can a trader do to decrease the likelihood of putting themselves in the above situation?
The primary issue that most new traders ignore is Money Management. Namely, never put more than 5% of the account size at risk at any one time. This does not mean 5% per trade. It means that no matter how many trades are open, if they all get stopped out at a loss, no more than 5% of the trading account will be gone.
Generally, traders who find that they lose large percentages of their accounts are those who ignore the above principles and take on too much risk relative to the size of their account.
Only Trade in the Direction of the Trend
By trading only the strongest trending pairs and only in the direction of the trend, the direction that the market is taking them, the trader will be entering trades that have a higher probability of success.
While employing the above two in one’s trading will not guarantee winning trades, they will put two more trading “edges” in place that can work in your favor.
---Written by Richard Krivo
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