Practical Money Management That Works
Submitted by User on July 14, 2011 - 18:20.
PRACTICAL MONEY MANAGEMENT THAT WORKS
Rule 1: Risk no more that 2% of account balance;
Rule 2: Use natural support / resistance to set the stop-loss; and
Rule 3: Use the range between current price and the proposed stop-loss to calculate lot size.
The golden rule of money management is "Never risk more than 2% of account funds on any one trade", which refers to the amount that may be lost, and not the amount that may be traded. You could trade 5%, 10%, even 20% of your account funds, but your stop-loss must not allow more than 2% of account funds to be at risk. Using this 2% risk factor and combining with the stop-loss range (number of pips), you can calculate the lot size that can be traded without exceeding your 2% risk factor if the stop-loss is triggered. The most important element in this calculation is the stop-loss.
SETTING THE STOP-LOSS: Any indicator that identifies support and resistance can be used. You could use lines drawn at support or resistance, or you could use a Moving Average, or Parabolic SAR, for example, provided your choice provides a clear reference point on the price chart. My preference is to use either a Moving Average or Parabolic SAR, as both of these automatically move with the price action and provide regular points at which to set my Trailing Stops. I will use Parabolic SAR in this example.
CALCULATE STOP-LOSS RANGE: For long position, subtract Parabolic SAR from the current price to determine number pips between Parabolic SAR and the current price. This is the stop-loss range.
CALCULATE 2% OF ACCOUNT FUNDS.