Feb 14: What It Means to Diversify your Forex Trading Strategies

by David Jenyns on February 14, 2007

Learning how to manage your money is the critical difference between who will win and who will lose in the business of forex market trading. If 100 forex traders begin trading by using a system with 60% of winning odds, only about 5 of those traders would see a profit by the end of the year. Despite those 60% winning odds, only 95% of those forex traders will lose because of poor money management skills. Many traders donít realize that anyone entering any trading system must have great money management skills in order to succeed. After all, traders enter the forex system to make a profit, not to lose money.

Money management will stand for the amount of money you will put on a trade and the risks you are willing to accept for that trade. In order to diversify your forex trading strategies, itís very important to understand the concept of managing money and also to understand the difference between managing money and trading decisions. There are a number of different strategies to use that will aspire to preserve your balance from any high risk liabilities.

First off, you will need to understand the term ďcore equity.Ē Basically the core equity illustrates the starting balance of the account and what amounts are in the open positions. Itís very important to understand the meaning of core equity because your money management will greatly depend on this equity. For instance, if you have an open account with a balance of $5,000 and you enter a trade with $1,000 that makes your core equity $4,000. If you enter another trade for another $1,000 then your core equity would be $3,000.

It would be better to begin diversifying your trades by using several different currencies, because by only trading one currency pair, you will generate very few entry signals. For example, if you have an account balance of $100,000 and have an open position for $10,000 then that makes your core equity $90,000. If you choose to enter on a second position, then calculate the 1% of risk from your core equity, but not your starting account balance. This would mean that the second trade would not exceed $900. Then if you decide to enter a third position, with core equity of $80,000 then the risk from that trade should not surpass $800. The key is to diversify the lots between all currencies that have a low correlation.

For instance, if you wanted to trade EUR/USD and GBP/USD with a $10,000 (1% risk) standard position size in money management, then it would be safe to trade $5,000 in each EUR/USD and GBP/USD. This way, you will only be risking 0.5% on each position.

Itís very important to understand the strategies of the Martingale and the Anti-Martingale, when trying to diversify your forex trading strategies. The Martingale rule means: increasing your risks when youíre losing. This strategy has been adopted by gamblers worldwide who claim that you should increase the sizes of your trades even when you are losing. Basically, gamblers use this rule in the following way: Bet $20, if you lose bet $40, if you loose bet $80, if you lose bet $160, if you lose bet $320, etc.

Ultimately, the strategy is to assume that if you lose more than four times, then the chances to win become bigger and as you add more money, you will be able to recover from your loss. Although there are many people who choose to use this strategy, the truth is, the odds are still the same 50/50 even regardless of the previous losses. Even if you lose five times in a row, the odds for your sixth bet, and even those there after, are still 50/50. This is an easy mistake made by those who are new to the trading business. For instance, if a trader started with a $10,000 balance and lost four trades of $1,000 a piece for a total of $4,000 then the traders remaining balance would be $6,000. If the trader thinks there is a higher chance of winning the fifth trade and increases the size of the position four times, enough to recover from the loss, then if the fifth trade loses the trader will be down to $2,000. A loss like this can never be recovered back to the $10,000 starting balance. Any experienced trader would never use such a risky gambling tactic, unless the tradersí goal was to lose all the money in a short period of time.

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