In this post, I’m going to discuss a simple forex trading money management strategy that increases your odds of winning without increasing your risk.
Sounds too good to be true? Read on..
Before I go into the details of this money management strategy, let’s first look at its prerequisite. In order for the strategy to work, you need to have a system that is profitable with a 1:1 Risk Reward ratio. This post will discuss one such trading system and demonstrate how applying the money management strategy increases its profitability, while simultaneously reducing its drawdown.
The Principal Behind the Strategy
Consider this: If you use a system with a R/R ratio of 1:1 and it’s profitable, that means the entry criteria that you use has at least a 50% chance of hitting the profit target. Suppose when you win, you gain $1 and when you lose, you lose $1. If your R/R ratio is 1:1 and your win percentage is only 50%, your system will break even (before commissions).
Now, what if when you win, you gain $1, but when you lose, you only lose $0.75? In that case, even with a 50% winning percentage, your system has a mathematical edge. If you take a total of 100 trades and 50% of them are winners, after 100 trades, you would have lost 50*0.75 = $37.5 but gained 50*1 = $50, resulting in a net profit of $12.5.
If price has an equal chance of moving x pips in your favor and x pips against you, but you win more (dollar-wise) when you are right and lose less when you are wrong, your system will be profitable. This is the basic principal behind the strategy.