By: Michael W. Knee
I once knew a very advanced martial arts instructor. He would only accept as students people who already had a black belt in some martial arts discipline, but it could be any martial arts discipline, he didn’t care which one. I thought that was rather odd, so I asked him about it. He told me that if someone has a black belt it means they know how to fall without getting hurt.
The same principal applies to trading forex, or trading anything for that matter. There are all sorts of fancy, complicated strategies out there that you can try, once you know how to fall without getting hurt. And the trading equivalent of falling without getting hurt is taking a loss without destroying your account.
If you keep trading for any length of time you will have some wins and you will have some losses. No one wins on every trade, and no one loses on every trade although it might feel like it sometimes. The name of the game is to make sure your wins exceed your losses, but to get there you have to make sure your losses don’t put you out of business first.
There are two steps to making sure your losses don’t put you out of business, or making sure you can fall without getting hurt. The first step is to never risk more than you can afford to lose. For a complete discussion of how to do that, go to 5minuteForex and click on Managing Risk, but the “elevator speech” version is never risk more than 2% of your account on a single trade.
The second step is to realize that wishing, hoping, and praying aren’t trading strategies. Neither is thinking that you know when the market is going to turn. If you put a trade on and it moves against you, when it gets to the stop-loss point you calculated in step one, get out. Don’t think “just a few more pips and it will turn.” It might very well happen that way, but it might not. And if it doesn’t turn, and you keep moving your stop, eventually you will find yourself out of business.
About nine months after I started trading I once made $20,000.00 in about half an hour. Naturally I immediately recognized myself as a genius, knew I had this trading thing down pat, and didn’t need that kindergarten risk management stuff any more. The next day I lost $7,000 in 20 minutes on a single trade. I sat there, watching it sink, knowing that I was right and it would turn any minute now. It didn’t. Fortunately for me I was working for a trading firm, and the manager made me get out of the trade before I lost everything. Otherwise my trading career could have ended right there.
Here is the crucial point: There is no force on earth that could have turned that into a winning trade. It was doomed to be a loser from the minute I put it on. But if I had been following good money management I would have lost $500.00 instead of $7,000.00.