Forex trading risk management is a very vital topic when it comes to forex trading. Traders naturally wish to keep their losses as little as possible. Also, they would like to extract as much profit as they can out of each trade.
Forex traders lose money not just due to lack of experience or knowledge but also because of poor risk management. Therefore, proper risk management is absolutely essential to a successful career in forex trading.
Making sense of Forex trading risk management
The forex market is sans doubt one of the biggest financial markets out there. More than USD 5 trillion is said to be traded each day. Banks, financial institutions, and individual traders stand to make massive profits and equally big losses. So banks have to practice credit risk management. Traders have to do the same to ensure ROI.
Forex trading risk is just the possible risk of loss that may take place when trading. It is noteworthy that risk management rules for forex are not limited only to forex trading.
Regardless of if you find risk management interesting in the context of energy trading, futures, stock/commodity trading, risk management basics are similar when trading with each instrument.
The risks are as shown :
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Market risk
The market can perform at variance with how you expect it to. When you think that the US dollar is about to appreciate against the Euro. Then, you decide to but the EUR/USD.bit then it plummets, and you lose money. ;
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Leverage risk
Traders use leverage to open trades that are more significant relative to the size of the trading account deposit. Sometimes, this can cause to more money being lost than deposited at the start in the account ;
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Interest rate risk
The interest rate obtainable in an economy can affect the value of the economy’s currency. this implies that traders can be at risk of sudden interest rate changes;
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Liquidity risk
Some trading instruments and currencies are more liquid relative to others. In case a currency pair has high liquidity, the implication is that there is no lack of either demand or supply. This facilitates swift trades’ execution. For less in-demand currencies, there could be a delay between you opening or closing a trade and the trade actually being executed. The trade is, hence, not executed at the expected price. Consequently, you make a smaller profit or even a loss. ;
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Risk of ruin
You face ruin when you run out of money executing trades. Suppose you have a long-term strategy for assessing how security’s value will change, yet it moves in the opposite direction. There has to be sufficient capital on your account to resist that move until the direction gets to be the way you’d like. When you have insufficient capital, your trade could be closed out automatically. You lose all that you invested in said trade. Whether the security moves in the direction you planned for will no longer matter.
Forex risk management: best tips
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Forex risk and trading self-education
Immerse yourself in everything forex. There’s actually a lot of free material out there. Help yourself to the plentiful resources at InvestBy and ABinvesting. ;
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Using a stop loss: What is the best risk management strategy for forex?
A stop-loss tool permits you to protect your trades from sudden market movements by letting you set a predefined price at which your trade will close automatically. Hence, if you enter a position in the hope, the asset will appreciate. Also, the asset declines in value when the stop-loss price is nudged. The trade will then close to prevent even more losses.
however, stop losses are no guarantee. There are times when the market acts unpredictably. Price gaps crop up. When this eventuates, the stop loss is not executed at the predetermined. Rather, it is activated the next time the price attains this level. The phenomenon is known as slippage.
A good benchmark is to set your stop loss at a level that implies you will lose no more than 2% of your trading balance for any particular trade.
After you have set your stop loss, you ought never increase the loss margin. There’s no point in using a safety net if you cannot put it properly in place.
There are diverse stop losses out there –
- Equity stop;
- Volatility stop;
- Margin stop;
- Chart stop.
Moreover, a protective stop can lock- In profits before the markets turn ;
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Secure your profits with a take profit
A take profit is not that much different from a stop loss. It does, however, have the opposite purpose. While a stop-loss automatically closes trades, a take profit automatically closes trades once they have hit a specific profit level.
When you know what you ought to expect from each trade, not only are you able to set a profit target, you can also determine what an appropriate risk level is for the trade. For example, trades in the main would be aiming at a 2:1 reward-to-risk ratio. Here, the expected is two times the risk they are ready to take on a trade.
If you set the trade profit at 40 pips above entry price, your stop loss would be set 20 pips below entry price ;
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Risk only what you can afford to lose
Novices are frequently guilty of breaking this cardinal rule. So the onus is on you to look after your interests in a volatile, unpredictable market.
In case a small loss sequence is sufficient to eradicate most of your trading capital, each trade is possibly taking on too much risk.
When you have a trading account of GBP 5000, and you lose GBP 1000. There’s a 20% loss. Covering that loss requires a 25% profit from the remaining capital in your account.
It becomes essential that you calculate the risk involved beforehand. When the profit chances are lower relative to the profit to gain, stop trading.
One rule asks you not to risk more than 2% of our account balance per trade. Moreover, traders adjust their position size to show the traded pair volatility. A more volatile currency asks for a smaller position relative to a less volatile pair.
You could, at some point, suffer a bad loss or burn thru a major portion of your trading capital. Naturally, there’s temptation after a big loss to have your investment back. However, you really ought not to take an additional risk when the account balance is already low.
It is vital to remain balanced, in position size terms as well as emotionally. Therefore, you could always pare down your trading size in a losing streak. Just waiting for a high probability trade is an option not to be treated with contempt ;
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Restricted leverage use
Leverage permits you the opportunity to magnify your profits made from your trading account. It can, however, similarly magnify your losses. The risk potential is, hence, on a roll. For example, a 1:30 leverage account implies that on $1000, you may place a trade worth up to $30000.
The implication here is that in case the market moves in your favour, you ought to experience the full benefit of that $30.00 trade – even if you invested only $1000. When the market moves against you, the opposite is true.
Your risk exposure to forex risk is hence higher with high leverage. When you are a beginner, a sensible approach as regards Forex risk management is to delimit your exposure by abstaining from using high leverage. Think only of using leverage when you have a clear idea of your potential losses. Failing to do this will put you on the wrong side of the forex market ;
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Your own forex trading plan