Many traders wait for an ideal moment to open a trade, which is no doubt an important factor. To manage the actual position and to recognize an ideal moment to close it are even more important. How to manage the position? Where to set a stop loss and what does the abbreviation RRR stand for? Read on!
I find money management to be each trader’s proprietary know-how. A higher level of know-how includes the capability of additional buying or selling of positions. However, we’d better start from the basics, each trader must learn.
As you already know, Forex trading requires discipline. First, you must decide for yourself how big the position you wish to open should be and how to identify it. I recommend that you calculate this against the size of your trading account. Conservative rules suggest that you shouldn’t risk more than 1 to 2 per cent per trade. Our video on money management advised 5%, since binary options trading is in essence much easier. Overall, I recommend that you set the risk at maximum 4% per day (not per trade)
My recommendation for a beginner whose trading account contains 10 000 usd would be no more than 500 usd per trade. The daily limit should be around i.e. 1 000 usd. This means that if you consume the limit, you should not open any more trades. In a situation like this, it’s better to quit, to analyze why this or that has happened (…was it your mistake or a false signal from the market) and carry on trading on the next business day.
Why use money management
Every long-term trader uses some method of money management. The reason is simple: To protect himself or herself against loss. Even a successful and consistently profitable trader experiences a series of losses and must be stopped by a stop loss. In a situation like this, I suggest you quit for the rest of the day and start on the next day with a fresh mind. This is a far better alternative to purging your trading account within a single day.
By the way, having no barrier in place such as stop loss is a frequent mistake made by many beginners unaware of money management, stop loss or RRR who are able to devastate their trading account within a single trade.
What is RRR
The abbreviation RRR stands for Risk-Reward-Ratio. If you set both your position’s stoploss and takeprofit (at the point of opening a trade) with a profit or loss worth 20 pips, your RRR is 1:1. This means that you may either earn or lose one dollar. If your potential profit is twice further than loss, than your take profit your RRR is 1:2.
Remember that Forex allows you a lower success rate than 50% (as you can see above, 1:2). This ratio allows you suffering 19 losses of the total of 30 trades, However, the rest i.e. 11 trades will generate profit. Figure out this using a stop loss of 100 and a take profit of 200: With 19 losses, your overall loss will be 1,900. With 11 gains your total gain will amount to 2,200. In total, you would earn 300.
RRR and where to place a stop loss
A universal rule says that RRR should not be lower than 1:1, i.e. your stop loss should not be placed below your take profit. Well, I agree – but on the other hand this rule is too general. If the ratio of your proven profit-making Forex strategy is somewhat worse than 1:1 don’t worry and continue trading like before. This rule should not be interpreted so rigidly. A small deviation from the rule will not stop the world going round. The one-to-one ratio is a recommendation allowing for exceptions rather than a rule.
Placing a stop loss depends on your RRR. This is what must be tested on historical data. Another factor not to ignore is psychology. There are traders whose otherwise profitable strategy is set at a75% loss, a figure others may hardly tolerate.
If you are keen to learn more about forex/cfd trading and seek for new information read one of our past articles: Seven reasons why traders keep losing money.
Best of luck, dear traders!