"Correct" Money Management for Forex?

Hello.

I'm still new to forex, so please bare with me.

1st Newbie Question:
When investing in stocks, a pretty standard money management practice is to divide your starting balance into equal units (for example, $10.000 : 5 = $2.500 per investment) and risk a desired percentage from each unit.

When trading with currencies, as far as I understand, it looks something like this:

Trade #|Core Equity|2% risk on each trade|Margin Debit (my investment)
1 | $20.000 | $400 | $1170,9 (EUR/USD)*
2 | $18.829 | $376 | $1097,7 (AUD/USD)*
3 | $17.732 | $354 | $1024,7 (NZD/USD)*
etc.
* I just took a basis of 1.4636 (EUR/USD) for each calculation, with a 2% risk and a 50 pip stop-loss.

Now, it may happen, than my first trade is going to be a looser, but my third trade turns out to be a winner. This means, that I would loose more with trade 1, because I had a bigger position and I would gain less with trade 3, because I had a smaller position.

Do I imagine this correctly?

2nd Newbie Question:
I plan to trade only 1 pair - EUR/USD. Let's say I go long @ 1.4500 and the pair shoots up by 50 pips in a few hours. I want to buy more of EUR/USD at 1.4550 because I'm "confident", that the price will continue to go up. The question is, how do I determine the size of my second position? Do I again calculate 2% of my core equity (the money which is left for making further investments), or do I take a smaller percentage this time? (because "pyramiding" or scaling in should be done with each position being smaller than the previous one)


I would be *very* grateful, if someone more experienced, and with more knowledge than me, could explain, how to handle the given situations correctly. Thank you in advance!

Erm. If you are to risk 2%, this means that you only put 2% in total up at any one time. So your total maximum risk at any one time, using your example, is $400. If you want to pyramid, then you have to risk $100 in the first trade and $100 for each subsequent trade. So if you have 4 positions, then the total you can lose is $400. However, if you move the stop for the first trade to break even, then you can risk that first $100 again.

shadowninja said:

Erm. If you are to risk 2%, this means that you only put 2% in total up at any one time. So your total maximum risk at any one time, using your example, is $400. If you want to pyramid, then you have to risk $100 in the first trade and $100 for each subsequent trade. So if you have 4 positions, then the total you can lose is $400. However, if you move the stop for the first trade to break even, then you can risk that first $100 again.

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Hi shadowninja. I thought I should risk 2% for each pair I want to invest in and if I had 4 simultaneous investments, my total account risk would be limited to 8%. I had this idea from reading this:

Trading one currnecy pair will generate few entry signals. It would be better to diversify your trades between several currencies. If you have 100,000$ balance and you have open position with 10,000$ then your core equity is 90,000$. If you want to enter a second position then you should calculate 1% risk of your core equity not of your starting balance!. Itmeans that the second trade risk should never be more than 900$. If you want to enter a 3rd position and your core equity is 80,000$ then the risk per 3rd trade should not exceed 800$.

Did I misinterpreted it?

In my view your position size should be relative to the market volatility in the time frame of your trade. So this would be different if you were trading GBP/USD that it is for EUR/USD. The key thing here is to have a measure of what that volatility is.


Paul

Trader333 said:

In my view your position size should be relative to the market volatility in the time frame of your trade. So this would be different if you were trading GBP/USD that it is for EUR/USD. The key thing here is to have a measure of what that volatility is.


Paul

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Hi, Paul.

But if we discard the volatility for now, are the above calculations correct? Should I take 2% of my core equity (core equity = starting balance - amount in open positions) for each trade than I plan to make?

In my view it depends on what time frame you are trading and how much of your capital you are comfortable risking. 2% is the maximum that I would be prepared to risk and that would be for overnight trades. Intra-day it would be a lot less for me.


Paul

I will use daily timeframe and I will hold my position from 7 to 10 days.

i use a maximum of 5% of my account on any given time.
i usually use 2% risk of my account per trade, if i have multiple trades open they usually account for 5-6% of my account. although some may find this risky, very rarely have all my positions that i have been into turned to losses.

pirx said:

Trading one currnecy pair will generate few entry signals. It would be better to diversify your trades between several currencies.

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Here is the BIG problem with having mutiple forex pair positions on at one time. Firstly, there are strong correllations between some pairs. For example, if you are long EUR/USD and GBP/USD at the same time and something positive came out in the USD (which you are short in both positions) then both trades will go against you at the same time.

Second, having multiple positions on can actually end up in your having an exposure you weren't expecting. An example is going long EUR/USD and long USD/CHF. That basically means you're long EUR/CHF since the two USD portions of the trades will at least partly cancel each other out. Now if you want to be long EUR/CHF, that's fine, but you need to know the true exposure of your account.

It's for these reasons that new forex traders really should stick to one pair at a time.

Rhody Trader said:

It's for these reasons that new forex traders really should stick to one pair at a time.

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Yup, I too am going to trade one pair only - EUR/USD.

Let's say that my first investment was 2% of my equity. And if I want to add another position, what do I do? Do I calculate again the 2% from the cash that is unused (my core equity), or do I add a smaller position this time?

Rhody Trader said:

It's for these reasons that new forex traders really should stick to one pair at a time.

Click to expand...

My thoughts exactly. While on the face of it, you appear to be diversifying, the reality is that you are not.

I think people mis-use that word; diversifying is supposed to reduce risk. This means you use some of your savings for trading, keep some in the bank, stick some in your pension plan and put some as a deposit towards a house. It does not mean buy 20 different currency pairs.

That's cool. But how do I scale in for my second, or even third position?

hi pirx - having confused me completely, I wonder if you should be doing this?

There are two different issues being discussed here, portfolio heat and pyramiding.

Ignoring the first.

In general when pyramiding the second and subsequent positions are recommended to be smaller than the first (so 1, 2/3, 1/3).

In general when pyramiding the total of all positions = the amount risked. This is because there are old traders and bold traders but almost no old bold traders.

So here 2 units (1 + 2/3 + 1/3) = 2% of portfolio.

You could push it a little harder if when you added the second part you had a stop in place on the first position that was beyond the entry giving you a hypothetical risk free position. The trouble with risk free is that its only risk free against normal market behaviour. A black swan event will whip past all our stops and give you a much worse beating than you ever expected (destroying the bold traders before they get to be old traders).

tomorton said:

hi pirx - having confused me completely, I wonder if you should be doing this?

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Don't worry, I'll get it eventually Your example for "scaling in" in stocks was superb and I've copied it to my money management sheet. See the attachment.

But I wasn't sure if it's the same for currencies.

If I decide to start with a $2.000 investment, then my second investment should be $1.333, and the third $666?