Money management, when  trend following, in the forex markets is handled a little different from what you may be used to.  If we use the traditional method in which we tie a percentage of our available equity to the stop loss, we may find it difficult to make much money at all.  The stop losses are usually much larger than many are used to.  But trust me.  The stop loss orders are almost NEVER HIT! The stop loss orders in my trend following system are there for a catastrophic failure in the early stages of a trade.  I exit losing trades and enter in the opposite direction long before the stop loss is hit.

My trend following system uses a leverage based model for money management.  The current state of the market determines what that leverage is when the trade is placed.  I’ve had trades with leverage as low as .5:1 (that’s 1/2 to 1).  I’ve also had leverage as high as 5:1.  It just depends on the trade.  I typically stick with 1:1 – 3:1 leverage.

To explain this, I’ll use a $1,000.00 account balance.  If I have a $1,000.00 account balance and I want to place a 3:1 leverage trade , I open an order for 3,000 units of the currency that I wish to trade.  You may be thinking that this is far too small.  That’s about 30 cents per pip.  You need to trade small if you want to win big, guys and girls.  You have to remember that if you can win a lot of money really fast, you can also lose money really fast.  Your market maker depends on it.  That’s why they give you 100:1 leverage.

Many of you want to trade 100,000 units for every $10,000.00 in your account.  Of course you do.  It’s fun to watch your account balance move up by $10.00 for every pip.  You can admit it.  We’ve all been there.  Trading at this level of leverage is absolute account suicide.

Now, when we decide what amount of money to base our leverage on, we have to first deduct any open risk.  That means that if I currently have a $10,000.00 balance and have trades open which have a $1,000.00 risk exposure (you could lose $1,000.00 in the worst case scenario), your leverage on the next position must be based on $9,000.00.  You must assume that the money is spent.  I like to think of open risk like a “check outstanding.”  it’s money that’s spent,  but has not yet shown up on my account.  Just because the equity is there does not mean that I can spend it, but that’s a blog post for another day.

Now, some notes -

Remember folks.  Manage your leverage.  If you don’t it will certainly manage you.  Few things feel worse than being in a trade, even a good trade, that turns against you when you are over-leveraged.  It is PAINFUL!  There is no other way to put it.

Also remember that 100:1 leverage is great, but you must know how to manage your own leverage.  You CANNOT trade 100:1 leverage unless your goal is a margin call.  Think of the 100:1 leverage as an open line of credit.  For every $1.00 you have on deposit, your broker will loan you $100.00.  Just because the bank will give me a 100:1 loan does not mean that I am willing to assume that risk.  Nor should you.  Trading is a business.  Run it like one.

Watch for more information on leverage management, risk management, and money management in the up-coming weeks.