Hello and welcome to another edition of the bulls vs the bears. Last time we touched on How To Manage Trades The Right Way. Today we are going to touch on how to manage your forex money like a pro using risk reward and position sizing. The one thing you do not want to do as a trader is get so hooked on a trade that you don’t think it can fail. Then you end up leveraging so huge on a trade, which sets your trading account for a nuclear-sized blow up.
All it takes is one such tsunami to cause a huge crater in your trading account. And when that happens you resort to emotional trading instead of logical trading. Rather than relying on your trading plan, you fall back on your emotions by jumping back into the market in a desperate attempt to make up for your losses. That’s suicide if you ask me. You need to have a clear understanding of risk reward and position sizing. Since I’m a pretty nice guy I’m going to show you a few tips on how to perfect these two scenarios:
Think in Probabilities
Risk Reward and Position Sizing is all about probabilities. It’s a complete waste of time searching for a silver bullet trading system that will take you the Promised Land of prosperity. Look, if you want to prosper as a forex trader, you need to understand how risk reward and position sizing works. You need to perceive each trade as a probability. That it has a reasonable chance of making you a profit. When you see forex trades this way, prosperity will find you very quickly and easily. In so doing, you will see the market more objectively instead of developing the mindset of a Las Vegas gambler.
Let me let you in on a little secret. Successful forex traders view the forex market as the implementation of their trading edge. By trading edge I’m referring to the prevailing conditions for their trades to help them make a profit. With that in mind, you then decide on how you are going to minimize the risk on the trade while at the same time, same time maximizing your reward(in this case profits). With the power of risk reward and position at your disposal, you are able to manage your risk on each trade.
Even more importantly, you ditch your gambler’s hat and wear the cap of a logical and disciplined trader. When you view the market this way, you will be better equipped to put a cap on your emotions because you know the possible risk and reward scenario before you enter the trade. With this information at your disposable, you don’t need to stare at your screen all day waiting for your profit to materialize. Instead you utilize the set and forget strategy. I can hear somebody asking”What the heck is that”? Well you set your take profit and stop loss and leave the market to work for you.
Just leave the house and chill for a bit so that by the time you get back home, your profit is already in your trading account. Even more important you are able to keep your emotions and sanity in check.
Now that we’ve got the bones out of the way, let’s get to the meat of the issue- Starting with:
Risk To Reward
It’s no secret that anytime you contemplate entering a trade, think about the risk to reward ratio. Let’s say you find a good trade setup, you first decide how much risk you will put on the trade. In other words, decide how much you can afford to part with. Risk management should be top of your priority risk. You should think risk management first, reward(profits) later. Not only are you a professional forex trader, you are also a risk manager. You need to treat forex trading as a business. Once you realize the importance of risk management you can then concentrate on being the best forex trader that you want to be. The rewards will take care of themselves.
Now let’s take a look at risk to reward in action using a pin bar setup below
Ladies and gentlemen, here is the pin bar setup. we s As some of you probably know the pin bar setup is one candlestick representing a sharp reversal or a strong price reversal It’s attributes are: along tail(popularly known as shadow or wick. And the area between the open and close of the candle is known as the full body.
Here we a bullish uptrend forming at the far left corner. I’m sure some of you who are familiar with the pin bar setup are saying to yourselves” Hmmmm…..this sure looks like a profitable setup.” However, think risk management first, rewards later. You first find the safest place to place your stop loss so you minimize the possibility of taking a nuclear-sized hit. Even more importantly, you want to give your trade more room to breath while you maximize your risk to ratio rewards.
In that case you place your stop loss just below the long tail of the pin bar. You only do this at the end of the downtrend. Anything beyond that and your trade is toast. The whole idea is to leave enough room beyond the long tail to avoid getting caught in the stop run. Now I can hear someone asking” Enough of the risk. How do I figure out my reward?”
Well it depends on the mood the market is in. As you can see, the market started on the uptrend. If you play your cards right, you could twice or even triple the risk. The bench mark ratio that most traders use is 1:2. In some cases most traders go as high as 1:3.
So basically this is an example of the risk reward setups that occur on the market regularly. Like I mentioned earleir, take care of your risk management and the rewards will take care of themselves.
If you want to know more about trading the pin bar look up How To Prosper From Trading The Pin Bar
Last but not least is:
Somebody once said that position sizing is the glue that hold risk reward scenarios together. You know what, he is absolutely right. The whole premise of position sizing is to fit your position size to to fit your stop loss. Let’s say you risk $100 after after spotting a delicious trade setup. Except that the most logical spot to place your stop loss is 200 pips away. In that case you reduce your position size to accommodate your stop loss, So if you are trading a $1 a pip you will slash it to .50 cents a pip. So your calculation would be .50 x 200=100.
Let’s take a look at an illustration using the AUDUSD pair.
Here you risk $100 but the sto loss is 109 pips further up because the safest spot for the stop loss is just below the pin bar. So you divide the risk amount by the stop loss(100/109), which gives .917.
That’s how position sizing is done. All you are doing is adjusting your lot size to accommodate the stop loss distance that gives you the best chance of making a decent profit. Anything opposite this formula is nothing but GREED. In this case greed will end up killing you. I dare add that position sizing combined with risk reward scenarios gives us the set and forget strategy I mentioned earlier. It sets your mind at ease and makes you objective and logical. Each trade you enter in is simply an execution of your trading edge. So there is no need for you to risk more than you should. And you can use this same trading edge on as may trades as possible. You don’t need to be hung up on one trade. That’s suicidal.
If you need help calculating your position size, consider using a position size calculator. It will help speed up things for you.
If you want to know more about position sizing look up Risk Management and Position Sizing- The Most Important Lesson in Money Management You Will Ever Learn
That’s a wrap for “How to Manage Your Forex Money Like A Pro.” If you want to prosper as a forex trader, then you better manage your trading cash properly. Forex trading is a business. And just like any other business, you need to look after your cash properly. You don’t leverage all your money on one trade and risk blowing your trading account. Just apply the right position size and risk to reward ratio and you will be laughing all the way to the bank.
Til next time take care.
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