Money Management, how the pro’s handle Money Management in the Forex Markets


Money Management: How do professionals utilize money management to manage risk and profit in the Forex markets?

Most of the professional managed funds in the Forex markets are operating systematic long term trend following models. Typically professional money managers share the following characteristics:

1. They risk n percent per trade, typically between 0 to 2%. Risk is determined by the distance between trade entry and the stop out point: the point at which an adverse move forces closure of the position. For example a trader with a US$100,000 account risking 1% of account equity will exit a trade on an adverse move of US$1000.

2. Stops are typically set as a function of recent volatility. Volatility is normally determined by an indicator such as ATR, or by using n day high / low price channels.

3. Correlation limits are typically employed to reduce correlation risk: the risk of multiple correlated markets producing concurrent adverse price moves in a portfolio.

Money management position sizing can be calculated as follows:

Trader has a US$100,000 trading account and wishes to risk 1% on a trade: US$1000. Trader wishes to buy the Euro currency against the US$ when it is trading at 1.4430 and wishes to risk 80 pips on the trade: what size should the buy order be?

US$1000 / .0080 = US$125,000.
If the position of US$125,000 moves against the trader by 80 pips, they are stopped out and loose US$1000 (plus slippage and commission).

Money managers differentiate their trading returns through:

1. Market selection: the number of instruments they are trading and the correlation between those instruments.

2. Stop placement exit strategy. Closer stops reduce holding period and reduce trade win %, wider stops increase holding period and improve trade win %.

Many of the best money managers are trading multiple uncorrelated or low correlated trading systems with multiple parameters with the desire to smooth account equity, minimize over-optimization risk, and for larger funds to work around liquidity issues on entry and exits.

Pyramiding into positions is typically not employed by long term trend followers, nor is scaling out of positions. Scaling out of trades normally works better on the shorter time frame as many loosing trades can be turned into ‘scratch’ trades by exiting half a position on one favorable excursion move of risk.

Extended periods of draw down in account equity are to be expected when trading long term trend following methods. Many of the best long term trend following managers add to their accounts during draw down in an attempt to benefit from a ‘reversion to the mean’ in long term trend following performance. Drawdown can be reduced by trading multiple uncorrelated systems and paying attention to correlation risk between instruments and the systems employed.