Sunday, October 12, 2008

Forex Money Managment Strategies, the Difference Between Success and Failure

Many people, specially new traders, overestimate the paramount importance money management has on their trading. In fact many strategies can be turned from losing to giving decent returns when adequate money management is applied to them. People tend to think (as I have said on other posts) that the most important factor in forex is the entry, they couldn't be more wrong. Most trading systems are profitable either because of their exits or their money management strategies, both of them give the systems an additional edge over other ones.

So, what is exactly money management ? It is simply the adequate control of position sizing inside a strategy to make it more profitable. As you know, there are many ways in which positions can be managed, the traditional approach being to trade a fixed percentage of your account size every time. However, this strategy is not as profitable as people would think because it needs a trading system which is right most of the time and whose exits are very favorable. The advantage is that this system is very good at preserving capital but up to date I have not seen a single system which has demonstrates on live trading to work well based on this money management.

So what systems work ? We have what we would call "progression systems" which increase lot sizes after any loses are attained. The most popular is the Martingale strategy which doubles lot size after each loss, however, if your equity is not infinite, this trading system will wipe out your account eventually because of lot sizes becoming obscenely large. Can it be traded profitably ? Sure, you can demo trade a martingale until it collapses then enter it and withdraw your profits every week, the system will eventually collapse and wipe your whole account but luckily you have made back your account and some additional money. Then you return to demo trading, wait for another collapse, etc. This strategy works because Martingales tend to trade in cycles, they collapse, produce profits, collapse, etc.

Since what we want is a trading system that does not fail with time, we have to find a compromise between increasing lot sizes after loses to recover capital and increasing them too much as to expose us to increase our risk too much. So here comes the variations of the D'Alambert money managment system. What this system does is increase lot sizes linearly with loses and decrease them with profits, so if you have 3 loses and 3 wins and your initial lot size is 1, your traded lots would have been, 1,2,3,2,1,1 . It has been shown with automated systems that variations of the D'Alambert system work the best, that is, not decreasing lot sizes linearly but increaseing them until new all time highs are achieved. These systems give a good compromise between risk and profits.

If you want to learn more about automated trading systems with different money managements and their profitabilities please consider buying my ebook on automated trading or subscribing to my weekly newsletter to receive updates and check the live and demo accounts I am running with several expert advisors. I hope you enjoyed the article !

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