This is the second most common trading mistakes traders make.I am constantly amazed at the number of Forex traders and brokers that have no concept of ‘money management.’Money management is controlling risk through the use of protective stops or hedging, while balancing the potentialfor profit against the potential for loss.Here is an example of poor money management that I see.
Almost daily... many traders refer to a trade that might lose $500 if they are wrong and make $1,000 if they are right as a two-to-one risk/reward ratio. This is usually considered a
“decent” trade. What is wrong is that it is just as important to know the proper win/loss ratio as knowing how much you are going to lose if you are wrong and how much you are going to make if you are right, but what are the odds of making money... of being right? What are your odds of
losing money, or being wrong?
Good money management means knowing a trade’s profit objective and the odds of being right or wrong and controlling the risk with protective stops. You are better off with a trade where you might lose $1,000 if you are wrong and make $500 if you are right, if the trade works eight times out of ten, than to take a trade where you make $1,000 if you are right and lose only $500 if you are wrong, but the trade works only one time out of three. Developing and testing money management concepts is the way to overcome this problem. An entire book could be written on
money management principles, but the key is to know your win percentages along with proper risk/reward ratios.
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