Weekly Trading Lesson: Money Management and the Use of Leverage

Last week we talked about the use of a 1:2 risk:reward ratio on our trades and the use of a trailing stop to manage those trades in an attempt to be consistently profitable. But we also have to keep track of our account balance so we have funds to be in a position to take the solid trading opportunities we find.

Too many new traders will open a trade using too much leverage in an attempt to get a big win. More often than not, these trades end up as losing more money than was necessary. I recommend only risking about 5% of your account balance at any one time. If you have a mini account with a balance of $2000, then you should risk no more than $100 on a trade. This way your losses will not keep you from having the funds to take the next trade. This does not mean to open 10 trades at once and risk $100 on each one, but to risk no more than 5% at any one time. Buying the GBP/USD and the EUR/USD at the same time is not really that different. You are looking for USD weakness in both trades which means that you are more than likely to profit on both or to lose on both. A better approach would be to open one trade risking 5% of your account balance and not open another trade until the trailing stop on the first trade is moved up to breakeven. Then your risk on the first trade is theoretically at zero and you can now risk that 5% on a new trading opportunity. If the market is trending strongly and offering many trading opportunities, you can take advantage of the situation by having multiple positions open at the same time while still risking no more than 5% of your equity. So when you think of money management, think about how much you are risking on the trade and how much of your account balance you are risking. They are both key elements to successful trading and should be an important part of your trading approach.