Education

Risk Management

The success or failure of your activity on the foreign exchange market is heavily dependent on how properly you manage risks. You can have the best trading strategy, great skills and vast knowledge but still keep wondering why your gains are constantly wiped out one way or another. The reason most likely lies in having no risk management applied to your strategy.

Risk management is a combination of multiple factors and rules applied to the trading process. Proper risk management implies significant amount of discipline involved and generally does not tolerate deviation from the set rules. It can be limiting your trade size, trading only during particular market hours or never risking more than particular percentage of your account into one trade. Also, important part of risk management is diversification of your portfolio –an experienced trader would most likely advice distributing your capital over a broader range of assets rather than putting everything into one trade. And while the latter is mostly applied to stocks or bonds where you go all in with all capital, forex trading generally gives more flexibility to investor by allowing to trade with minimum capital requirements and small trade size.

Why is Forex Risk Management Important?

Proper risk management forms the groundwork of healthy account operation. Though it may seem easy to grasp for the majority of traders, the actual application might have some underlying potential problems that might be trickier than initially seems. For example, most brokers in the industry offer highly leveraged trading accounts to traders, which keeps them focused on potential gains but make fully oblivious to the risk of loss. This makes traders have a false sense of security and come to the platform with anticipation to reap the rewards in fastest way possible. It seems achievable with a touch of a button especially to those who did it on demo account, but once the real funds come in the actual experience generally gets completely different from those the user had on demo. That’s where the risk management comes to the rescue.

Controlling Losses

The basic function of risk management is mitigating the losses to a minimum level possible while at the time keeping the account growth exponential. You should always know how much you can potentially lose should the trade go in the unexpected direction. Setting the stop loss to a particular percentage of your trading account is the easiest way to make sure you will never lose more than you can afford to. Repeating this with each subsequent trade order will help you develop a discipline to uphold this rule on the permanent basis.

Figuring out where to place the stop loss requires some understanding of charts and analysis, but the main thing is to be aware how far your trade can get off the track before you start feeling really uncomfortable. Generally, it is not recommended to risk more than 1% of your capital for each trade.

Once your stop loss is set in your head, or on your trading platform, stick with it. It is easy to fall into the trap of moving your stop loss farther and farther out. If you do this, you are not cutting your losses effectively, and it will ruin you in the end.

Choosing the right lot size

Choosing the right lot size should be your rule of thumb. And while brokers heavily advertise highly leveraged accounts with 300:1 or 200:1 leverage, allowing to open 100,000 USD position with only $500 o your balance – do the reality check. Higher leverage means higher gains but at the same time makes the prospect of partial or full loss of funds on your account as real as ever. And while trading with high leverage can benefit traders with high account balances, trading with high volume while having small funds on the account is the easiest way to have your funds wiped out and your confidence ruined as a result.

The best rule of thumb is to be as conservative as you can. Not everyone has $5,000 to open an account with, but it is important to understand the risk of using larger lots with a small account balance. Keeping a smaller lot size will allow you to stay flexible and manage your trades with logic rather than emotions.

Conclusions

Trading on the financial market has underlying risks which may bring disastrous consequences to the trader if those risks are left uncontrolled. The more disciplined is the trader, the greater are the prospects of success. Forex trading is about choosing an opportunity and traders need to act once those opportunities arise. However, always keep in mind that you can never maintain 100% accuracy of prediction as market is driven by forces we can barely keep under control. Using proper risk management can be the difference between becoming a forex professional, or being an ordinary cash burner.