Money Management in Forex Systems

One of the essential parts of any Forex trading strategy is money management. Forex trading systems often neglect to cover this topic, but every Forex trader needs a method to manage his or her resources.

Forex systems have trading strategies for recognizing entry and exit signals, but may fail to address the most essential underlying factor - money management. Money is the basic resource in Forex trading, so Forex trading systems must incorporate a system to manage this commodity.

There are many ways to approach money management. Most systems of money management use the concept of core equity. Simply put, core equity is the starting balance minus the money tied up in open positions. Forex systems should use core equity as a guideline for capital risk.

Investors are advised to use Forex trading systems which limit risk to 1% of the value of each trade. Therefore, if you are trading a standard Forex lot of $100,000 your risk limit should be $1000. Similarly, if you are trading mini lots worth $10,000, your risk limit should be $100.

Core equity is used in conjunction with risk limiting. Forex systems which combine these two concepts work something like this: If your starting balance is $10,000 and you are trading a standard lot of $100,000, your risk limit is $1000, or 10% of your starting balance.

Since $1000 is tied up in a transaction, your core equity has dropped to $9,000. This means that a second transaction should limit risk to $900 or 0.9% of a standard lot.

How to Limit Risk

Forex trading systems use stop loss orders to limit risk. In our example above, the first transaction would be entered with a stop loss order 100 pips from the entry position. The second transaction would have a stop loss order of 90 pips from the entry position.

Remember, these are for trades of standard lots worth $100,000. If you are trading mini lots, your stop loss orders would be 10 pips and 9 pips respectively.

Adjusting Risk Limits

Some Forex trading systems allow for higher risk levels on profits. For example, if your starting balance was $10,000 and you made $5,000 in profitable trades, you may wish to risk a higher amount on your realized profits. Some Forex systems advise increasing risk limit to as high as 5% on realized profits. This safeguards your initial balance while increasing your profit potential on your already realized profits.