Capital management on the Forex market

Forex capital management is an extremely important element of trading. It is said that finding the right time to open and close a position is only half the battle. The other half is good position size management and risk handling, i.e. Money Management. It is this element that mainly determines how much we will earn or lose and include bankruptcy. Risk control in the long term will definitely contribute to more stable and better results, compared to the situation if we omitted or only periodically neglected this factor.

Risk appetite

To start controlling risk first you need to determine what we have risk appetite, i.e. how much we are ready to lose on a single transaction and what percentage of our capital is this amount. In the literature you can find information that such an ideal value is 2%, 3% or 5% of capital. Of course, there is no universal value that would be appropriate. It all depends on the individual preferences of each investor, i.e. how ready he is to risky playing. Of course, the risk in the range of 1-5% can be considered low and it is relatively safe to use it. However, this does not mean that you cannot play with an average risk of 10%. Values ​​above 25% are getting closer to gambling because they cause the bankruptcy of an account to cause a short series of lossy transactions.

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The lower the percentage, the lower the risk, which is also a single loss on the bill. But this is also a smaller profit. Hence, one has to compromise in determining our value. This should be done by assessing our capabilities transaction system, which we know the characteristics of and we know what to expect from it, i.e. how many average transactions in a row are lossy, what slippage in pips in the long term we can come across, and what is its effectiveness (the number of profitable transactions compared to all transactions).

How will the balance of both accounts with a $ 10 deposit with different risk change in a situation where we record 000 lossy transactions from the government?

Fund commitment limit

In account A with 2% risk capital loss was 18,29% while in account B with 5% risk it was up to 40,13%. This shows how important the choice of the risk value is. If our system tends to complete a series of losses, a low risk is indicated, while if it is highly effective, you can think of a higher value.

Some people take into account the percentage of capital they will use to open a position. Rightly so, but it should only be an additional factor. Reaching the limit of commitment of a certain amount of funds set by us may limit the risk by "preventing" us from opening new positions, which could contribute to faster reaching the level of margin Call or increasing the loss if the market turns sharply.

Another, additional security condition is to determine the risk on the entire account, eg on a daily or weekly basis. This means that, for example, we set 10% risk on a weekly basis and if we achieve such default by Wednesday, we do not conclude further transactions, and for us it is a signal that it is time to properly analyze our decisions and think about where we make a mistake.

Selection of the size of the item

Now that we have a fixed risk value expressed as a percentage of our capital, we also know how much we have on our account. It remains, therefore, to choose the volume of transaction volume so as not to lose more than we expect. The most reasonable solution is to set the volume depending on what size Stop Loss is for us (the reverse approach would cause that Stop Loss could fall out in strange, not entirely sensible places). The mechanism of action is best shown on an example.

Example:

If we have 10 USD in the account and we trade the EUR / USD pair and we risk 000% of the deposit, it means that we may lose 2 USD in a single transaction. In the event that our system indicates that the Stop Loss is 200 pips from the opening price, we should adjust the volume so as not to lose more than $ 20.0. In this case it will be 200 lots. If Stop Loss is 1.0 pips, the appropriate lot would be 60.0 ... No broker provides such a precise volume, so if we offer microlots, we should round it to 0.3333, while if we do not have them available, it is 0.33. It also makes more sense to round ALWAYS down. Thanks to this, we will not lead to an "forced" increase in risk.

Helpful articles:

• How much is one pips worth?
• How do you count the security deposit?
• What is financial leverage?

The power of compound interest

By playing a fixed risk, along with the melting capital, our loss is reduced in amount - it is logical since one depends on the other. However, when analyzing it the other way, we have more capital with each profit, so we earn more and more, based on the same risk threshold. Thanks to this, we use the power of compound interest. This is best illustrated by an example where we compare a situation where we have a fixed TP and play on one account with a fixed volume with a profit of 2% of the initial deposit, and on the other we increase it by obtaining 2% of the deposit from each transaction. As before, 10 transactions in a row will end up on a TP account with $ 10.

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Risk to Profit ratio

As you can see, even with such a low value as 2%, with 10 transactions, the difference is almost 2%, although we make the same transaction all the time and only gradually increase the volume by a small amount. With the next items, the difference will clearly increase.

Risk: Reward - this is the last factor that should be considered when managing your capital. If we decide to invest in the currency market, we rather do it not for hobby reasons, to kill the free time. Usually, we are driven by the goal of achieving a profit that will exceed that on bank deposits, bonds, or other low-risk, but also low-profit instruments. Such an action must pay off. So it's worth taking care of it at the level of a single transaction. This is what the risk to profit ratio tells us, i.e. how much we can lose on a single transaction compared to how much we can earn. If the Stop Loss is 100.0 pips, a TP just 25.0 pips, which means we can lose four times more than we gain (4: 1 ratio). This is not a very profitable undertaking. While maintaining such proportions, we must record over 4 transactions ending with TP so that our activities bring income.

However, it is not said that you can not act like this. It is simply more risky. If our system is characterized by high efficiency and we often include small TP with a wide SL, it may turn out that it will also increase the state of our account.

In spite of everything, beginners are usually recommended to play with 1: 2 (TP 2x bigger than SL), because it is theoretically easier to achieve bigger TP every time than to swim on a wave of high efficiency all the time.