Now that you have a basic understanding of Forex trading and the differences between fundamental and technical analysis, the next critical area is the one of money management.  Many Forex traders devise great strategies that would have yielded significant profits had they not depleted their bankroll with a few unfortunate early trades that went against them.  In Forex there are no sure trades – no matter what your strategy, it is always possible for a given trade to be a loser.

Good Forex trading strategies will yield results over the course of time.  Within a given day’s, week’s or month’s trades, anything can happen.  Smart Forex traders understand this and devise money management parameters that allow them to absorb temporary adverse results retaining sufficient funds to remain in the game.  Money management often proves to be the most critical factor within an overall Forex trading strategy.

A good initial rule of thumb is not to risk more than 3% of your entire account value on any one trade.  As you progress within the Forex arena it is acceptable to increase this threshold to up to 7%.  However, until you develop a higher level of expertise, it is advisable to strictly remain within this 3% limit and avoid the temptation to exceed it no matter how attractive any one Forex trade opportunity appears.

By limiting your exposure for loss to 3% of your portfolio from any one bad trade, you are able to have staying power and emerge from inevitable bad streaks fully able to capitalize on the good streaks, which are always sure to come.  Reckless new participants often risk too much, and after just a few initial bad trades, see their account balance depleted.  Ensure you do not fall victim to this scenario.

The next aspect of money management relates to what is termed as “leverage.”  In Forex trading, leverage can be either your best friend or your worst enemy.  To understand leverage, think of a traditional home mortgage.  Assume you are buying a house for $300,000.  You put down $60,000 down payment and borrow the other $240,000 from the bank.  Further assume you sell this house for $360,000.  You made $60,000 profit, and it was done with only investing $60,000 of your own cash.  This represents a whopping 100% ROI (return on investment).

However, assume that you paid for the house in cash.  In this scenario your $60,000 profit would be return on invested cash of $300,000, thus representing a much lower 20% return on investment.  The same exact phenomenon occurs in Forex trading; however, the levels of leverage that can be employed are much greater than seen in home mortgages.  In Forex trading, some accounts allow you to lever 400:1.  This means you can buy $400,000 worth of a given currency while only investing $1000 of your own cash.

In this scenario, the smallest of gains in the currency you bought can translate to huge profits.  A 1% movement would yield $4000 in profits coming from only a $1000 cash investment.  However, it is critical to analyze the other side of the equation.  A .33% movement to the downside would cause immediate loss of your entire $1000 investment.  Both gains as well as losses are magnified when using leverage.

New Forex traders are strongly urged to use leverage sparingly on initial trades.  Many Forex trading software packages have built in limiters to prevent you from creating too much exposure from any one given trade.  Before you make that first Forex trade, make sure you have fully thought out your money management plan