Money Management 101

ďThere are old traders and there are bold traders, but there are no old bold traders.Ē

Proper money management is one of the most important aspects of trading, advocated by professionals, but often ignored by beginners. Why? Simply because you have a chance to make more (and lose more) money by trading a bigger position size, greed is at work here.

We are all fueled by 2 basic emotions Ė greed and fear, and they drive us to take uneccessary risks. At itís core, money management is all about controlling risk.

If you start with a small account, donít expect to make big money

Trying to turn a $500 account into a $8000 account in 3 months like what those gurus that advertise on newspapers claim they can do is dangerous and impractical. Consider this.

Person A has a $500 forex account. Assume risk exposure is 2% per trade, thatís $10.
Person B has a $5000 forex account. Assume risk exposure is 2% per trade, thatís $100.

There is a trade in EURUSD with a potential risk to reward of 50 pips to 100 pips, but that 50 pips of risk is handled differently by A and B.

50 pips to A will be $10. So a 1 pip tick for A will be 50 pips divided by $10 which works out to 20 cents. Aís maximum position size for that trade is 2 micro contracts.
50 pips to B will be $100. So a 1 pip tick for A will be 50 pips divided by $100 which works out to 2 dollars. Aís maximum position size for that trade is 2 mini contracts.

The trade is successful. A made $20 and B made $200, or 4% of their account. Assume that every week they make 3 winning trades and 2 losing ones with the same risk and reward in a week. A will earn $40 every week, thatís $160 in a month. This is assuming he keeps winning every month.

Alternate scenario 1

Person A has a $500 forex account. Assume risk exposure is 2% per trade, thatís $10.
Person B has a $5000 forex account. Assume risk exposure is 2% per trade, thatís $100.
Now both A & B are trading with 1 mini and guess what? A can only handle 10 pips stop loss while B can handle 100 pips.

Alternate scenario 2

Person A has a $5000 forex account. Assume risk exposure is 2% per trade, thatís $100.
Person B has a $5000 forex account. Assume risk exposure is 10% per trade, thatís $500.
Both A & B enters every single trades together, but they had a lousy day and gotten 3 straight losses.
Aís losses Ė 1st trade: $100, 2nd trade: $98, 3rd trade: $96.04. Result: A ended up with $4705.96.
Bís losses Ė 1st trade: $500, 2nd trade: $450, 3rd trade $405. Result: B ended up with $3645.

Closing thoughts

So who will be a better trader in the future? No one knows but B is likely to crash and burn faster than A agree?

I hope this puts things into perspective.
Respect money management and stop trading like a gambler folks.
Give yourself a chance to swim in a pool of money by taking one small step at a time.