Since many many more traders have lost money trading foreign exchange than have made it (a penetrating glimpse into the obvious), most traders lack the knowledge about knowing how to lose. A review of the trading literature reveals very little written about losing money.

Losing has received only extremely superficial coverage in the vast ocean of books written on the topic of trading FX over the last 50 years. This dissertation is a light treatise on the lost topic of risk management, as well as the psychology of losing, and was intended for the serious student who views trading as a business. FX Traders who have either consistently lost money (paying their tuition), or would like to protect themselves against losing what they’ve made would fall into this category.

What you need is not a long litany of complex mathematical formulas or psychological theories, but a base risk infrastructure to help you understand, accept, and avoid catastrophic losses. Despite all the thousands of books written on how to make money in trading FX, 90% still continue to lose. To excel in trading FX, all traders have to come to terms with this fundamental principal of learning how to lose.

Given the negative odds inherent in FX trading, the goal of money management is to increase the likelihood of high probability trades. While your trading system or analysis techniques tell you what, when and how to trade, a money management strategy tells you how much to trade.

In both ‘Market Wizards’ books authored by Jack Schwager, when asked where risk management ranked against all the other aspects of a trading plan, the one and only reoccurring theme, the one and only common denominator was Risk Management.

Literally all of the Market Wizards clearly stated that it’s PARAMOUNT / NUMERO UNO. The Market Wizards considered it their primary responsibility not to lose money. These grandmasters could all make extraordinary money in totally contradictory ways because they all knew how to control their losses. According to these trading legends, the key secret to controlling risk is the ability to contain losses before it leads to ruin. This sacred rule is rudimentary and intrinsic to successful trading. It would be impossible for me to overemphasize the severe implications of adhering to green beret, navy seal type money management.

Most FX traders seem to unwillingly overlook the role of proper money manager risk control in a successful system. Instead, they waste their time searching for the Holy Grail with an 80% winning ratio. Unfortunately, great trading rules are meaningless if you don’t control risk and allocate your money properly. The object of the game is to manage your trades and money in such a way that you can survive enough small losers and still be around to enjoy the less frequent winners by cutting losses. You can make exceptional money with a less than 50% win ratio.

As Edwin LeFevre, author of Reminiscences of A Stock Operator wrote; "The trader’s deadly enemies are: Ignorance, greed, fear, and hope." While these internal enemies may never be totally conquered, effective risk control techniques can minimize their negative influences. A rational risk control strategy, in turn, will lead to fewer and less costly unprofitable trades. In FX trading, it is absolutely inevitable that losses will prevail.

TRADING STOPS: An absence of money management is the surest route to trading destruction. Following your rules is fundamental to success. In fact, more important then getting in and out of trades, they keep you in the game and maintain the life force. There will be lots of losses, just as there are losses in any business. Trying to avoid taking losses altogether is ‘the loser’s curse’.

Without clarifying risk and disaster management, you don’t have a trading system, you’re gambling. "I can’t get out here; I’m losing too much." - Loser’s famous last words. Great traders are far more concerned with giving away as few ticks as possible on a losing trade. Disciplined consistency is the key to success in the FX markets.

Money Management is so important that traders should actually spend 60% of their time and resources developing money management strategies, and the other 40% developing their actual trading strategies. All money management techniques have the same objective--to optimize your trading size and loss parameters for peak performance. Regardless of the strategy, you’ll never realize your full potential trading without both a winning ensemble of analysis techniques and a sound money management system.

The nature of the stop-loss order allows a certain degree of risk management, but it does not allow the user to absolutely define the amount of risk. As stated in the risk disclosure statement issued by the CFTC:

Placing contingency orders, such as "Stop-Loss" or "Stop Limit" orders will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders.

The CLASSIC FUTURES TRADER’S PARANOIA: Futures brokers and locals are adversaries in the trading pit. They clearly have different agendas. Think about it. When a broker fills an order for a customer, the broker is paid a commission, whether the customer makes money or loses money. If the customer stops trading because he always loses, then the broker’s commission will cease. The broker obviously wants his clients to make winning trades so they will enter more orders and he will in turn make more commissions. The broker doesn’t want the local trader to have any advantages over his customers because that will only help put the broker out of business.

So why would the broker tell the locals in the pit about your stop-losses? They don’t. Professional traders know where the stop-loss orders are, but not because someone told them: They know because the stops are always in the same place--a universal principal that is also true in the world of FX trading. Since we all look at the same charts and we all read the same books, it shouldn’t come as any great revelation that we all put our stops in approximately the same places following the same rules and guidelines. The overriding concern is the amount of risk that a trader is willing to take.

WHERE TO TURN While institutions and banks spend hundreds of thousands of dollars on software to manage the risk of their complex trading strategies for CTAs, CPOs, and FX fund managers. Independent traders’ pockets aren’t nearly as deep. Finding the right software solution creates an interesting dilemma. The independent FX trader faces the toughest predicament: Finding risk management software that is designed solely for the individual is almost impossible. We found one product that is designed specifically for the independent trader, TRADING RECIPES. Based on Dynamic Money Management, the system performs testing in multiple markets and multiple systems at once.

IN CLOSING, any successful FX trading system must offer good timing signals, but timing alone clearly does not guarantee profitable results. While good timing is essential, the addition of key money management techniques rigorously applied can truly mean the difference between moderate success and the accumulation of substantial wealth. I wish all the best in trading, lots of small losses and much abundance and prosperity.