These rules for money management are designed to facilitate preservation of deposits and ensure safety of operations with the biggest profit. They are also referred to as the rules of money management (MM). Today’s trade requires strict compliance with MM rules, but does not guarantee profit.
The following conditions should be met in order to ensure safety of deposits.
1. The total sum of money invested should not exceed 50 % of the total capital. This principle establishes the rule for calculating margins for open positions. Many analysts believe that the percent of money invested should be even smaller – 5 % - 30 %. Note that this is the total sum we are talking about (invested in several transactions). In other words, this rule does not mean that investing 50 % of the deposit in one transaction is reasonable.
2. The total sum of money invested in one transaction should not exceed 10 %-15 % of the total capital. In this case, the trader is protected from investing excess money in one transaction and, thus, going bankrupt. Figuratively speaking, this rule is similar to that of not putting all eggs in one basket.
3. The norm of risk for each open transaction defined by the Stop Loss level should not exceed 5% of the total sum of the capital. Thus, if the transaction proves unprofitable, the trader is ready to lose no more than 5 % of the total sum of his/her money. The figure of 5 % is taken from Murphy, whereas, for example, Elder’s figure is 1.5 %-2 %.
4. The total sum of margins required to open a position in one group of markets should be no more than 20 %-25 % of the total capital, which is based on the fact that many currencies behave similarly against dollar, especially after the release of economic news on the USA. That is why, it is necessary to work using both currency pairs including dollar and cross-rates in order to diversify risks. This way, losses resulting from open positions will be covered, at least partly, by the profit generated by other positions.
There are rules for setting Stop-Loss and Take-Profit levels when opening positions. All currency pairs are divided into those with high and low volatility. The majority of traders conduct so-called intraday trades when positions are opened for 1-3 hours. These positions follow the main intraday movements of the market. You should have sound reasons to carry the position over to the next day. The size of currency volatility defines a so-called “price noise” level that is determined approximately using the following method: take 24-hour candle from zero to zero hour GMT, measure their length between the shadows (the distance between “high” and “low” points in pips) and divide the resulting value by 24. The experience shows that the minimum value of the price noise is approximately 30 points, and such currency instruments are of low volatility. If the price noise value is of 40 points and higher, the currency instrument is of high volatility. For the intra-day trading, there is no use in setting the Stop-Loss lower than the price noise value, which means that Stop-Order value cannot be set to be smaller than 35 points.
5. Stop-Loss/Take-Profit ratio being set for one open position cannot be smaller than approximately 1:2; in other words, keeping in mind the above said, the Stop-Loss value cannot be set to be smaller than 35 points, whereas Take-Profit value cannot, accordingly, be smaller than 60 points. With successful/unsuccessful transaction ratio of 1:1, this rule allows you to have a small profit on the account.
There is a set of rules that should be followed when conducting trading operations. Generally speaking, the trader must maintain strict discipline and be well-organized to work at FOREX, as well as apply a systematic approach to work. With intraday trading, you should comply with a certain set of rules on a daily basis.
1. When you open a trading terminal in the beginning of the day, you should analyze the current state of the market, i. e. you should answer the following questions: What are the prices now and why and What was happening while the terminal was switched off and the trader was not monitoring the movement of prices.
2. You should review the economic news calendar for today. What time (GMT) the news is published at, what news is published and how it can influence the market and price movements. Skills of fundamental analysis only come with practice, so you need to gain practical experience in trading.
3. You should identify current support/resistance levels for the main currency instruments used in trading and current intraday price range.
4. Based on the analysis performed, you should make up a trading plan for the day, i. e. the level of prices that should be reached to enter the market and the Stop-Loss level to be set; a potential size of profit and, correspondingly, the Take-Profit level; conditions for entering and exiting the market; price situation that will be considered critical and require immediate exit from the market. You should understand that in your decisions to enter the market you should be guided by the conclusions drawn from analysis and you should not react to current losses from open positions or positions carried over to the next day. Before you open a position you must clearly plan the duration of transaction, and after expiration of the planned period of time you should examine the possibility to exit the market before any significant changes in prices occur as a result of market movements.
5. You should strictly comply with the trading plan. When you enter the market you should answer the question: What is the reason for entering the market? The reason for this should be a match between conclusions of the analysis and current price situation confirmed by technical indicators (at least two).
6. It is strictly forbidden to shift the Stop-Loss level calculated earlier to increase the potential loss whatever the situation is. Setting no stop levels is considered even riskier.
7. When you enter the market, you should take into consideration potential movements of the currency exchange rates after the release of economic news. Dramatic, short-term movements of currency exchange rates can break Stop orders and the market will move in the direction defined by the trader. Thirty minutes before the release of economic news that can influence currency exchange rates significantly, you should not open new positions; instead, you should secure current positions by shifting Stop orders to a no-loss point or by closing current positions taking into consideration possible exchange rate fluctuations.
Whereas the above rules cover, primarily, the process of getting ready for transactions and trading itself, further we will discuss how you can analyze the history of transactions and what major factors should be taken into account, apart from deposit or money growth rate.