The technical part of your system discussed previously only solves half of the difficulty. The equally important and other half is represented by the money management element.
A very good money management technique gives the chance to you to be extremely lucrative with your system even if let us say, out of ten trades, five are losers. Of course, if you construct your system respecting all the rules above and the rules that will follow you will not be in this scenario, but if for any reason you should find yourself in it, right and strict money management rules will make you prosperous even in situations like this mentioned.
Money management system is the subsystem of the forex trading strategy which controls how much you risk when you get an entry signal from your forex trading strategy. One of the greatest cash management approaches used by many professional forex dealers is to always risk a fixed percentage of your equity (e.g. 3%) per location. By making use of this approach a trader reduces when he is losing the size of his trades and slowly increases the size of his trades while he is winning. Increasing the size of bets during a winning streak allows for a geometric increase of the dealer’s statement (also known as gain compounding). Reducing the size of bets during a losing streak minimizes the damage to the dealer’s equity.
Trading on forex enables to multiply your statement over time – or to make it grow geometrically. Geometric capital increase is created when the gains are reinvested into the trading which leads to increasingly larger positions being taken and, hence, to bigger profits and losses. The pace at which the account grows is controlled by the size of the gains and by their frequency (which should always be remembered by forex trading system developers). While the geometric equity growth can and should be smooth (i.e. consistent), some dealers attempt to hasten it by artificially inflating the size of their profits by risking very high percentages of their statement. Because the real sequence of the winning and the losing trades can never be predicted in advance, such practice results in very erratic trading operation (i.e. sharp equity changes). Among other things this practice betrays the dealer’s lack of confidence in his or her trading system’s long-term profit potential. As long as the trader is confident about his trading system he can risk small percentages (%1 to 3%) of his statement on every trade and just view the system recognize its potential. It should be noted that only the geometric capital increase permits to make regular profit withdrawals from an account (as a specific percentage of the equity) without seriously affecting a trading system’s money making skill. This contrasts sharply with the fixed-dollar-stake money management system (e.g. always risk $500 per trade) whose profits grow arithmetically and where each withdrawal from the account sets the system a fixed amount of profitable trades back in time.
Both proper money management and sound trading strategy are required for a smooth geometric capital development. The speed (i.e. “geometricity”) and the smoothness of the account’s development depend on how much you risk per trade (as set by the cash management system) and on the trading system’s truth and the return ratio parameters (trading system’s mathematical expectation). Apart from the controlling equity changes by establishing a fixed percentage of the capital to be risked on any commerce, cash management system can also reduce equity swings through diversification (dividing your risk capital among unrelated currency pairs/trading systems).