Money Management in FOREX Using Pareto Law
How can I manage my money in FOREX?, How can I control my money while trading and direct it in the positive way always and avoid to lose much money in such an aggressive and fast market?
These and much more questions are being asked daily by a lot of traders around the world, most of these questions are focusing on the best ways to get profits, from a long experience trading FOREX I could say that the best way to get profits in FOREX market is to avoid or at least reduce loss and this can be achieved by a good money and risk management technique. A lot f these techniques were studied and published, a lot more are being published daily.
One of the best techniques I studied and used was applying Pareto law to the trading system, this law states “for many events, roughly 80% of the effects come from 20% of the causes.”, this law is also known as the 80-20 rule, the Pareto principle, the law of the vital few and the principle of factor sparsity and it was named after the Italian economist Vilfredo Pareto who noticed that 80% of the lands in Italy was owned by 20% of the population at that time.
How can we use this as a money management technique?, while it is not hard to use this principle for that purpose it’s not easy to keep running in FOREX market “specially for fast traders and scalpers” because it requires to organize and observe trading , writing down every trade you enter and analyzing these trades digitally to get a specific results like which pairs are the best for your trading system and give the best return, what are the best suitable times for trading and which trading systems are the most profitable trading strategies.
Still we have to discuss the mechanism of integrating the Pareto principle into money management system for FOREX trading, as I mentioned above it is not hard to use and apply it to the trading system, it is very flexible so you can apply it in many ways like :
1. Some people will observe trades and will from the result of this observation focus on the most profitable 20% of pairs those gave them 80% of income during exercise period which I recommend it to be at least 3 months.
2. Some others will be focusing time of trading, getting the most suitable 20% time of trading for them “times of successful trades” that they made 80% of successful trades during and of that they can know when the most they are trading successfully.
3. Stop loss and take profit points are important spots to be highlighted by this system, imagine how much will you save if you know the 20% take profit points that gave you 80% of the return and the 20% stop loss points that gave you 80% of your loss, so you can get the best ranges to use when you setup a take profit or stop loss point “i.e. if get 80% of my return of 20% of take profits that ranges 50 pips, I would setup my take profit points around that number always and vice versa in stop loss points case”.
4. Others would be focusing on trading systems, indicating which are the responsible systems for the most of profits or the most of losses in that period of time.
There are a lot of other factors in FOREX trading for achieving gain that can be observed and analyzed based on this principle, combining three to four f them would maximize your profits and reduce your losses dramatically but this is the most hard way to maintain a suitable money management strategy using Pareto law as this requires you to observe your trades and organize them for a long time accurately, this only would affect your trading negatively as you would not be able to enter short term trades easily if you do not have good tools to do.
This is why I recommend you to put every element in a spreadsheet separately and trade in a normal mood, after the examining period over you would be having a lot of data to analyze and get the results for them, hence you would have the ability to combine the results and get the best overall result for the best pairs you are trading profitably, the best take profit and stop loss points ranges and the best time you are trading them, combining these best results you will have a new result which would be for sure the responsible for around 80% of you return.
Once this get done, you are having a suitable FOREX money management strategy that you can depend on, but try to update it always to get the best out of it and notice that “80%” and “20%” are the theoretical numbers, they will differ for sure while keeping just around them.
Mihai holds a BA in Political Science, and before becoming active in the investment sector worked for almost 3 years as web designer and IT trainer for his own small company. He thinks that trading has always been somewhere at the back of his head, so when he first heard about Forex he knew that this is where he would find the professional satisfaction and challenge he was looking for.
Seriously though, that last one ain’t bad. Assuming you use a volatility based stop, you can optimize for the terms “constant,” “constant2″ and “power_factor”, as well as how you calculate the volatility, to find something that works pretty well for your particular system, goals and risk tolerance.
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