Forex trading and Poker have many similarities, the art of risk and money management being one.
A terminology used in poker when a player pushes all his chips over the line, putting everything at risk on one hand is called “ALL IN”.
If the player had their full capital on the table and went “ALL IN” and lost the hand they likely would not be back at the tables for a while, if ever.
If the same player had not encountered an “ALL IN” situation but still had a bad night at the tables (with their full capital) they could still lose it all by losing smaller pots (hands) over the session.
However, If this poker player sat down at the table with only a small percentage of their bank roll (capital) and went “ALL IN” and then lost the hand, it is not going to hurt them too much apart from a bruised ego.
Even if they lost the lot through small hands it would still not be the end of their poker career.
So how does this relate to forex trading? The vast majority of forex traders don’t risk their full trading capital on one trade (An “ALL IN” scenario) although I have seen many new traders who have.
What they do tend to do is put their full capital into a trading account from Day 1 (All their chips on the table).
When you consider that many new traders have no real understanding of price action, news or fundamentals this is not a prudent risk management approach.
Here is an alternative approach worth considering…
A Money Allocation Plan
A money allocation plan is a methodology of protecting your capital by allocating different percentages of your total funds over a period of time as opposed to depositing it all on day 1.
When new forex traders start they tend to get very excited about the markets and hack away at the charts trying to hit the big score, overtrading in the process.
It is generally something new traders need to get out of their system until they reach the eureka moment that quality over quantity is the better more profitable approach.
What would our money allocation plan look like? if, for example your total trading funds is $10,000, you would invest only 10% of this ($1,000) in your first month of trading and gradually add your additional funds over the following six months in incremental percentages.
This provides you with the opportunity to trade small and learn as you go as opposed to executing larger trades relative to your full trading capital and risking too much too soon in the process.
Intraday Trading – Daily Stop Loss Limits
Let’s move on to what the maximum amount you should be risking when actively trading.
What you generally hear in the forex trading market is that you should not risk more than 1% of your account on any one trade.
That’s fine for an experienced trader with an edge who knows what they are doing but not for a new trader who is still trying to find a trading methodology that works.
If your hell bent on trading a live account, I recommend that you use the money allocation plan above and don’t risk more than 1% a day for the first month (This is 1% of 10% of your capital) regardless of how many trades you do. You can then gradually increase your risk if you see a marked improvement in you results.
Limiting how much you lose to the levels recommended below will keep you in the forex game longer as you better understand how to read and trade this market.
When you combine this with your new money allocation approach, in month one, you are effectively only risking 0.01% per day of your total capital
(10% of $10,000 = $1,000 x 1% = $10 per day (10,000/10 = 0.01%).
Frustrating as it might sound, these early few months is were you are going to make all your novice trading mistakes and hopefully over time you will improve your knowledge and understanding of this market and start seeing results.
Compare this with most new traders who risk up to 10% of their full capital on one trade from Day 1. This is 100 times more risk.
Can you see how the “ALL IN” trader with his full capital on the table and too much exposure gets wiped out and gives up within the first few months? They risked too much, too soon with limited knowledge.
Swing Trading – Weekly Stop Loss Limits
If your a Swing Trader (keep trades open for up to a week) you would need to modify the stop loss limit.
A maximum risk of 2.5% of your account each week for the first month and gradually increasing your risk from there, again dependent on how consistent your results are.
The temptation to trade is strong but you must remember that trading is a profession that takes time and effort to consistently make money.
Some make it, many don’t, so if you are going to trade a live account start with protecting your capital first, take it slow, minimise your risk and forget the urge to go “ALL IN” if you want to stay in the game.