How to manage your forex margin effectively
While successful traders will overall win more than they lose, be assured they will experience losses. A good trader will control his or her use of leverage so they can keep trading and add to their winning record.
Lets assume a simple strategy and reason about the effect of different levels of leverage. The strategy will execute trades and then apply a 1 unit stop loss and take profit. Assume it wins 55% of the time. This strategy will produce infinite wealth, provided the trader doesn't go broke first, given enough time / trading opportunities. So obviously not going broke really matters.
Then the probability of getting infinitely rich varies with the size of our initial margin according to the function 1 - ((1 - probability of winning) / (probability of winning)) ^ number of units of initial margin.
Which looks like this….
|initial margin||P(infinite wealth)|
So lets say we are trading 100,000 eurusd. We place 20 pip stop loss and take profits on each trade. Then we expect to win or lose 200 usd on each trade. If we only had margin of 200 usd, or 1 unit of our expected pnl per trade, we would only have an 18.18% chance of making it. If we increase our margin to 5000 usd we are 99.34% more likely to have infinite wealth.
Now all we have to do is find that strategy that has a guaranteed 55% winning ratio that sets up all the time.
Answers on a postcard please.