MONEY MANAGEMENT

Money management is a way Forex traders control their money flow. Money management in the foreign exchange currency market requires educating yourself in a variety of financial areas.

The Forex, or foreign currency exchange, is all about money. Money from all over the world is bought, sold and traded. On the Forex, anyone can buy and sell currency and with possibly come out ahead in the end. When dealing with the foreign currency exchange, it is possible to buy the currency of one country, sell it and make a profit. For example, a broker might buy a Japanese yen when the yen to dollar ratio increases, then sell the yens and buy back American dollars for a profit.

Successfully managing your money in forex trading requires an understanding of the bid/ask spread.

The bid/ask spread is the difference between the price at which something is offered for sale and the price that it is actually purchased for. For instance, if the ask price is 100 dollars, and the bid is 102 dollars then the difference is two dollars, the spread. Many forex traders trade on margin. Trading on margin is buying and selling assets that are worth more than the money in your account. Since currency exchange rates on any given day are usually less than two percent, forex trading is done with a small margin.

Two very important concepts of forex money management are leverage and margin. Leverage allows forex traders to invest much more into currency trading than is available in their trading accounts. Thus, forex traders can operate larger funds. Margin is the real funds that are required to be held in the trading account as collateral to cover any possible losses.

Forex Money Management: Leverage

Leverage can also work against you in forex trading. For example, if a currency moves against your expectations, the leverage would multiply your loss by the same factor as it would multiply the gain.

Forex Money Management: Margin

When you buy €100,000 worth of currencies, you are in fact borrowing €99,000 for your purchases. The €1,000 that is used to cover your losses is the margin. A trader may choose the highest leverage (200:1), with the margin being only 0.5%. However, sound money management principles say that the trader should never trade huge lots. This would prevent leverage from hurting the trader.
Therefore, it is essential to understand how much leverage your forex broker offers and what the margin requirements are. If you are new to trading, you should compare the leverage and margin specifications of different brokers.

Remember that forex trading is speculation, so be careful when managing your funds and only invest what you can afford to risk.