Forex trading involves significant risks. Forex should be traded within the limits of potential risk, that is, within the limits of the amount that an investor can bear to lose.
At the same time, there is no need to exaggerate the fear of trading risks. As a trader, you should take reasonable risks, taking into account potential rewards, and striving to reduce your risk as much as possible.
Effective trading risk management enables currency traders to reduce losses that occur as a result of exchange rate fluctuations. Thus, having an adequate Forex risk management plan can make currency trading safer, more controlled, and less stressful. In this article, we cover the basics of forex risk management and the best way to incorporate it into your process.
What is trading risk management?
Trading risk management includes individual measures that allow traders to protect against the downside of trading. More risk means more chance for big returns - but also more chance for big losses. Therefore, the ability to manage risk levels to minimize loss, while maximizing profits, is an essential skill for any trader.
How does a trader do this? Trading risk management can include determining the correct size of a position, determining stop losses, and controlling emotions when entering and exiting positions. If executed well, these measures can prove to be the difference between profitable trading and losing everything.
1. Risk appetite
Exercising your risk appetite is essential in managing appropriate risk trading. Traders should ask: How much do I want to lose on a single trade? This is especially important for more volatile currency pairs, such as some emerging market currencies. Also, liquidity in forex trading is a factor that affects risk management, as declining liquid currency pairs may mean that it is difficult to enter and exit positions at the price you want.
If you do not know how satisfied you are with a loss, your position size may be higher than it should be, resulting in losses that may affect your ability to transact on the next trade - or worse.
Let's say 50% of your trades are winners. In the long term, mathematically, you can expect multiple losing trades in a row. During a professional trading period of 10,000 trades, the odds are that you will face 13 consecutive losses at some point. This underscores the importance of knowing your appetite for risk, as you must be prepared, with sufficient funds in your account, when malfunction occurs.
So how much should you risk? A good rule of thumb is to risk only 1 to 3% of your account balance per trade. So, for example, if you have an account of $ 100,000, the risk amount is $ 1,000 - $ 3,000.
2. The size of the position
It is important to determine the right position size, or the number of lots you take in a trade, because the right size will protect your account and increase chances. To determine the size of your position, you need to determine your stop position, determine your risk ratio, and evaluate pip cost and contract size. To learn more about how to do these things, click on the link above.
3. Stop losses
Using stop loss orders - which are placed to close trading when a specified price is reached - is another key concept for understanding effective risk management in forex trading. Knowing in advance at which point you want to exit a position means that you can prevent potentially large losses. But where is this point? Generally speaking, this is the point where the idea of initial trading gets nullified. For more details on this concept, click on the “Use stop loss orders” link above.
4. The influence
Forex leverage allows traders to gain more exposure than their trading account would allow, which means greater profit potential, as well as higher risk. Hence, financial leverage should be managed carefully.
While researching how traders perform based on the amount of trading capital used, Jeremy Wagner, Chief Strategist at DailyFX, found that traders with smaller balances in their accounts, in general, have much higher leverage than traders with larger balances. However, traders with lower leverage achieved much better results than traders with smaller equity using levels greater than 20 to 1. Traders with greater balance (using average leverage of 5 to 1) were 80% more profitable. Most of the smaller scale traders (using average leverage 26 to 1).
Based on this information, at least when starting out, it is recommended that traders be very careful in using leverage and be mindful of the risks it poses.
5. Control your emotions and deliberate objectively
It is important to be able to manage trading emotions when risking your money in any financial market. Letting excitement, greed, fear, or boredom influence your decisions could put you at undue risk. To help you get your emotions out of the equation and trade objectively, keeping a Forex trading log or log can help you hone your strategies based on past data - not according to your feelings.
Forex Risk Management: A Case Study
FBS Trader Bishoy Adil explains the trade he has made on the EUR / USD pair, illustrating the processes involved in sound Forex risk management.
“I opened a long position on EUR / USD at 1.1100 with a risk / reward ratio of 1: 3 and a position size of £ 5 per pip, which is only 3% of my account balance. This was a catchy trade on the charts and meant that I would have earned £ 300 if the target had been met.
I said below, I wouldn't feel comfortable with the deal. I chose 1: 1 leverage. It means doing all of these things, minimizing emotions and managing risks in the most effective way possible.
Trading Risk Management: Fast Ways
In short, to practice solid trading risk management, traders should do the following:
Determine your position on risk, thinking about the risk / reward ratio, position size, and the account equity ratio for each trade
Place stop losses to protect the market going against their position
Be careful of swaying and using too much
Maintaining dealing with your emotions
Use a journal to make decisions based on existing data rather than personal feelings.