In general, money management is a rather interesting and exciting topic. But it usually becomes interesting when you already have a tested trading strategy that gives a positive result.
So, we proceed from theory to practice. Consider the initial screen with a price chart.
We will not go into details of the calculation of certain indicators, because we are especially interested in their applicability in our money management system
Let’s analyze the bottom panel in more detail:
- Balance: this is the amount of our cash currently.
- Funds: this is the number of our funds, taking into account open transactions.
Example: if an open transaction currently shows “+ $ 100”, and our balance is $ 5000, then in the “funds” column we will see $ 5100.
If the transaction is closed with this profit, then the specified $ 100 will go into our “balance”. And then already the “balance” will be equal to $ 5100
- Free margin: this is the number of funds available for opening transactions.
The fact is that a certain “collateral” is required to open a transaction. It is withheld from the account of the trader at the time the transaction is opened. Depending on your leverage and the volume of the transaction, the amount of this security may vary.
Let’s look at an example:
As you can see, I opened a deal to sell GBP / USD at a price of 1.4222, the volume of which is 1 lot. To secure this transaction, $ 284.44 is deducted from my account. When closing a transaction (it doesn’t matter – with profit or loss), this amount will be returned back to my account.
You can also see that the “free margin” at the moment is $ 4725.56. If we add our margin to this amount (“$ 284.44”), we get $ 5,010. This happened because my position is in profit ($ 10). As you know, the more profit your open positions are, the more new deals you can potentially provide. On the other hand, if your positions are at a loss, the ability to open new deals, on the contrary, will decrease.
The margin level column shows the% that your funds are in relation to the current margin. In our case, the funds are equal to $ 5010, and the margin is $ 284.44. Thus, 5010 / 284.44 = 17.6136 or 1761.36%.
Thus, when the “Margin Level” will approach 100%, it will mean that almost all of your available funds are “busy” to ensure open transactions. In money management, this doesn’t help us much, because how to bring to a value close to 100% there will only be very gambling guys who do not particularly have a place in trading =)
So, what we need from all this business: we need only “balance” – it is from him that we will build on. “Why aren’t the tools important?” – someone will ask. They are not important because they distract from important things: looking at the “means”, you see the result of a transaction not yet open. If it will be in profit, the trader will rejoice. If at a loss – upset. It is simply not practical to look at the result of a transaction that has not yet been closed, because the effectiveness of the trading system consists only of closed transactions. Therefore, we discard all that is superfluous – only “balance”, only hardcore.
It is simply not practical to look at the result of a transaction that has not yet been closed, because the effectiveness of the trading system consists only of closed transactions.
Now we’ll work on the first rule of money management: identify the risk of the transaction.
Suppose we do not want to risk more than 3% in each transaction. How to achieve this?
To do this, we need to know what is:
- the cost of 1 point;
- the value of stop-loss;
The cost of a point is, in a simple way, how much you will earn if the price goes the right way by 1 point. Or how much you lose if you go 1 point against you. This value depends on the volume of your transaction (lot size).
I opened a deal for the sale of 1 lot at a price of 1.4222 (well, you remember). Now the price is around 1.4217.
Therefore, the price went in my direction 5 points: 1.4222 – 1.4217
My profit is $ 50
With a simple mathematical technique, we get that the cost of a point = $ 50/5 = $ 10
For a different transaction volume, the point value will be different. For example, if the transaction volume is 0.1 lots, then the value of the item will be $ 1. If the volume is 0.01 lots, then the value of the item will be $ 0.1, etc.
We proceed to the calculation of the stop loss.
So, if I know that the value of a pip for my volume = $ 10, then what will be the maximum stop loss?
We decided that we did not want to risk more than 3% of the total deposit in 1 transaction, i.e. in our case – no more than $ 150.
Thus, we obtain:
- Cost of 1 point = $ 10
- Maximum risk = $ 150
Max. stop loss = $ 150 / $ 10 = 15 points.
Therefore, any stop-loss that is less than 15 points fits well with our money management rules. If the stop loss is more than 15 points, you must skip the deal or reduce its volume.
If the amount of reasonable stop loss contradicts your risk management rules, you must skip the deal or reduce its volume.
For example, if in the current market conditions a reasonable stop loss is 30 points, and our maximum risk is $ 150 (it always amounts to 3% of the deposit), then first we need to calculate the desired point value:
Point value = $ 150 / $ 30 = $ 5
We remember with you that at an item cost of $ 10, the volume was 1 lot.
In order not to bother, we look at how many times the current value of an item is less than $ 10.
10 $ / 5 $ = 2. I.e. we need to reduce the transaction volume by 2 times, and this means to enter the volume of 0.5 lots instead of 1 lot.
If you didn’t get such a beautiful value for the item (not $ 5, but, for example, $ 3.33), then you can do the same: $ 10 / $ 3.33 = 3. That is, the transaction volume of 1 lot needs to be reduced by 3 times – therefore, it will be equal to 0.3 lots.
The money management method, when we use the same% of the deposit for stop loss, is called “Fixed-fractional”.
Thus, after receiving a stop loss, our deposit is 1000 – 30 = $ 970
In the next transaction, the maximum risk will not be $ 30, but $ 29.1, because our deposit has decreased, and 3% of it (in dollar terms) will become less.
The method allows you to competently approach the most important goal of trading – saving money.
The downside is that your stop-loss is triggered by a “larger” deposit, and you get a “take profit” from a smaller one. Let’s look at an example:
Suppose our take profit is equal to stop loss (and you plan to earn money due to the good probability of profitable trades). We also assume that the first transaction is closed at a loss and the second transaction – at a profit.
The result of the second transaction: $ 970 + $ 29.1 = $ 999.1
Thus, according to the results of 2 transactions with the same parameters, it turns out that we are a bit in the red. However, for trading this is natural: if you think about it, its essence is based on the advantage: If, for example, you have 50/50 profitable and loss-making transactions (provided that stop-loss = take profit), then by the end you will be in the red due to the spread. Thus, you need to be “a little better” even to just stay put.
Consider also another money management method called “ fixed proportional ”.
Its essence is easier to explain with an example:
Suppose that with a deposit of $ 1,000, we traded in a volume of 1 lot. This 1 lot brought us $ 500 in profit, and we decide to increase our volume to 2 lots.
So, according to the fixed-proportional method, the next increase in the lot will happen only when each of these 2 lots will bring us $ 500.
Therefore: 2 * 500 = $ 1000 – our deposit should increase by so much that we increase the volume to 3 lots.
Suppose that this happened, and our deposit is now equal to 1500 + 1000 = $ 2500
For the next increase, we need each of the 3 lots to bring in $ 500 profit: 3 * 500 = 1500.
Therefore, we will increase the volume to 4 lots when there are 2500 + 1500 = $ 4000 on our account. Etc.
Regarding the choice of the amount of profit that each lot should bring, I am for simplicity. To take in a simple way half of your deposit amount is, in my opinion, a good idea. It is advisable not to make it too small.
Note that it is not necessary to trade any even number of lots. You can start with a volume of 0.3 lots, and when you reach the target amount of profit, increase it to 0.6, the next border will be a volume of 0.9 lots, etc. The point here is precisely in the progression – first the initial volume, then increase by 2 times, then by 3, etc.
To summarize, I will say this: if you are just starting, then do not worry about all these mathematical calculi, but rather, just fill your hand with trade. Take the system from the Internet, reject a lot of transactions on it, listen to your feelings. Like it or not? If not, we are looking for another trading system and do the same with it. I don’t want to do this, because you don’t seem to know where this will lead, and our brain wants certainty. So, I suggest you remember how you learned to walk – did you know in advance how to do this? Have you read any theory while walking? Did you take any courses? =) Do not be afraid, remember how you trusted yourself in childhood in research matters.
When you find “yours” (just by feeling), it makes sense to add a little money management – take a fixed% of the deposit and continue to bargain. There will be new thoughts – try to apply, test, look at the result. And when the result suits you, then you can screw all kinds of “fixed-proportional things” there. You will also need to look whether this is suitable for your system, your probability of profitable/loss-making transactions and your take-stop / stop value =) The main thing is to gradually and progressively, without rushing anywhere.
I hope the article was helpful. Good luck with trading!