Risk management should be an integral part of everyone’s Forex strategy as market forces are beyond our control. Currency exchange rates may be predicted, but accuracy varies and surprises are still possible. So, how to manage risk in Forex trading? Here are the key elements of Forex trading risk management. These ten insights will help you reduce losses.
1. Forex Trading Risk is Always There
By definition, Forex is never risk-free. You bet on the direction of the largest market in the world. A trader uses real money to earn real profits. One cannot eliminate Forex trading risk, and it is impossible to win all the time.
When a majority of your trades are right, you are successful. You need to protect what you already have before raising the bar. Fortunately, trading tools and diverse portfolios make trading safer.
2. Forex Trading Risk Management
Traders often fail to set Stop Loss and Take Profit, although these are basic precautions. They are accessible through all popular terminals. Users pre-set the desired price for exiting a trade, so their losses are limited in case of failure. These features determine the result of your trades, so there are no surprises.
Without Stop Loss, your losses may go through the roof. Experts recommend you position it about 10-15 pips lower than the opening price. Without sufficient buffer, you may get stopped out. As your decisions cannot be perfect all the time, the importance of the feature is undeniable.
Take Profit should not be disregarded either. Trades will be executed automatically, bringing you the pre-set profit. It is advisable to follow a 1:2 ratio. For every pip risked, you should expect 2 pips of profit.
Before opening a position, any trader should have a clear understanding of how much they can afford to lose, and how much they would like to gain. Make sure that stop loss and take profit are set for every single order you place.
3. Seek out Confluence
Confluence is another cornerstone of risk management in Forex trading. It is observed when two different measurements lead you to the same conclusion. In Forex, you need at least two indicators pointing in the same direction, for example, price and volume. Never trade on a single indicator alone.
Individual indicators can give off wrong signals on their own. Therefore, always look for confirmation. You don’t want to lose money, do you?
4. Follow a Consistent Plan
Never underestimate consistency. All too often, traders act on urges and hunches. Suppress the urge to stray away from your plan. Focus on the big picture and do not be distracted by momentary changes.
When pursuing a long-term strategy, you may be tempted to make additional trades when the market seems exceptionally favorable. When a single trade makes a loss, you may feel the urge to chase those losses, opening more and more trades and magnifying the damage eventually.
Nobody becomes a stellar trader overnight. Learning takes time and requires effort. You may compare it to a muscle that needs exercise to get stronger. Do not abandon your strategy due to some temporary emotional states.
Naturally, your plan must be realistic. Set reasonable goals and develop steps to achieve them. Do not expect to make a million in a month. Too many things depend on your investment, skills, and mental agility. Unrealistic targets may cause you to feel frustrated and quit trading altogether.
Allow profits to accumulate gradually over time, and do not rush it. Unfortunately, Forex is not always fun. Can you think of many exciting things which are also extremely profitable?
Consistency is the cornerstone of success. A thorough strategy will help you avoid irrational decisions.
5. Do not Risk More Than You Should
Rookies may risk too much on a single trade. It is advisable to follow the 1-percent rule. This means you can only afford to risk up to 1% of capital per trade. This principle must be followed religiously if you want your account to last longer. For example, with $5,000 in your balance, each trade may put up to $50 at stake.
Overconfident traders may open positions with unjustified risks. For instance, they may open a trade for $1,000 when there is just $3,000 in total. A single misstep wipes out a third of their deposit! A series of such decisions – and you will have zero to trade with and only yourself to blame.
6. Be Careful with Leverage
Leverage is irresistible. The broker offers to boost your buying power, why miss out on the opportunity? In fact, you should, and the reason is also tied to risk.
As your volume grows, so do potential losses. Someone using 1:100 leverage can open trades for $100,000 when there is just $1,000 in their account. A single bad decision will leave them empty-pocketed.
Leverage is not evil by itself, but it must be used by weathered professionals. Stick to what you have before you gain expertise. Beginners should steer clear of leverage altogether. Leverage may be compared to a friend who encourages you to stay up all night and get into trouble. Even experts use leverage with extreme caution, and reliable brokerage site include warnings about trading on margin.
7. Diversify to Succeed
Seasoned investors never rely on a single asset. It is acceptable for Forex beginners to stick to a pair they know best. For example, a resident of the EU may feel comfortable trading the EUR/USD pair. While its dynamics are familiar, they should expand their arsenal over time.
Dependence on a single instrument gives no room for maneuver. If the market is clearly against you, there is nothing you can do but wait. However, if there are other assets in your portfolio, you may continue making profit elsewhere. This strategy provides backup, so risks are spread over a set of different markets.
8. Take Emotions Out of the Equation
Humans are emotional creatures. Strong feelings hamper trading victories, as your judgment is clouded. It is crucial to cultivate stress-resistance and resilience. Trade mindfully: always analyze your motives for each trade. Are you following your strategy or giving in to a momentary urge? In times of panic, investors often rush to short sell everything they have. This is a classic example of impulsive behavior.
The market always goes through ups and downs, so a plunge is not the end of the world. Every decision must be based on at least two factors pointing in the same direction and level-headed analysis of the market situation. Do not trade when you are angry, depressed, or overjoyed. If you notice any such state, refrain from trading until it passes.
9. Know How the Market Works
Every financial market sees rises and falls, but patterns may be discerned and used to your advantage. These are not chaotic. Traders should be aware of typical irregularities and structure strategies accordingly. Your market may be trending or ranging, and both states may be exploited. Knowledge will allow you to spot the best entry points and see when adverse movements are most likely.
10. Use Your Mistakes
Finally, take your own mistakes in stride. Failures are simply inevitable, as even the most triumphant traders are not infallible. Blunders should be perceived as learning opportunities. Use them to improve your course of action and make more accurate predictions in the future.
How to Manage Risk in Forex Trading: The Right Approach
In a risky environment like Forex, mistakes are part of your experience. Even experts err once in a while. Still, you should make blunders as rare as possible.
Keep a trading journal and note down details of each decision, so you can review performance regularly. Nobody starts out knowing it all. Make perpetual improvement in your personal mantra.