Risk management is, hands down, one of the most important skills you can take advantage of when trading with foreign currencies. In fact, risk management is an important aspect of every financial affair or investment strategy you consider and try to implement in your plan for a successful life.
Ironically enough, risk management tends to be one of the most overlooked and neglected areas in forex trading too which is reflected clearly in the statistics and shows an average of 90% of forex trading beginners experiencing loss and failure at the initial stage of their real-life trading experience.
A big reason for this common experience of failure is due to the lack of risk management.
It is wrong to think that you can risk as much as you can stomach to lose on a single trade because this is what gamblers do. However, forex trading has nothing to do with gambling and if you are looking for long-term success and good returns the strategy of “hitting the jackpot” with a single trade is not how you should approach forex.
At the end of the day, following the risk management rules is what makes you differ from gamblers as a forex trader and these rules are on your side, they are here to protect you, guide you, increase your chance of becoming profitable in a long run.
In a nutshell, risk management reflects your abilities and skills to tilt every little factor in your favour as much as you can on the forex market. In order to minimise the likelihood of financial loss, you need to have in place some risk management tactics, strategies, precautions, and actions.
Here are 7 effective risk management actions to help you calm down your adrenaline rush, not trigger your inner gambling instinct, and make sure that you are on the right way of being a forex trader.
1. Determine your risk tolerance
Trading, no matter the market, usually involves risk to some extent and your personal risk tolerance is an individual factor that will affect your trading experience and decisions.
Commonly, advanced forex traders recommend a risk per trade no beyond 5%, however, 1% or 2% of the total value of the account is the best for forex trading beginners. In a nutshell, your comfort with the risk you can take is mostly determined by your level of experience but also your individuality as a person.
Lack of knowledge, experience, and familiarity with forex trading, in general, is why new traders can’t stomach a major loss that easily and this is why they prefer to utilise a smaller percentage of risk levels. However, with time and by gaining experience and familiarity with the system you may start feeling more confident in what you do and feel comfortable with a higher level of risk but once again, you are recommended to be cautious and don’t go higher than 5%.
At the end of the day, the higher the percentage of your account you are risking, the faster you will drain your account completely if you fall into a string of losses which is not uncommon. So even with advanced and experienced forex traders, it makes more sense to have a good risk management strategy rather than risking a lot on a single trade.
2. Position sizing
Your position size is, in fact, more important than your entry and exit when trading with forex. Whenever your position size is too big or too small, you are practically not following the rules of risk management and you are either taking too much or too little risk.
While risk tolerance is, once again, a matter of personal determination and decision, risk management rules and guidelines in forex can help you establish the right position size depending on your level of experience and the size of your account that will help you prevent evaporating your trading account in the blink of an eye.
In a nutshell, the position or the trade size is how many lots you take on a trade. Mainly, there are micro, mini, and standard lots and forex trading beginners are normally recommended to work with micro and mini lots.
In order to determine the right forex position size for your account while keeping risk management in mind, you want to follow the simple mathematical formula: Pips at Risk X Pip Value X Lots Traded = $ At Risk. If you trade mini lots, then each pip movement is $1 and every mini lot position result in a risk of $10. With micro lots each pip movement is $0.1, resulting in a risk of $1 per lot position. The position size should be perfectly adjusted and calibrated to your account, the speculations of the trade, and the risk management strategy you are following. Here is one helpful tool for you – the BabyPips’ Position Size Calculator.
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3. Managing your trading time
The forex market is open 24/5 and there will be many times that you will miss opportunities as a trader because you were not on the computer. However, this does not mean that you have to be trading non-stop. It is a significantly better strategy to make sure that you are available to place trades when good opportunities arise which means that you need to manage your trading time in a smart way.
The average forex trader is an average person with a full-time job, a family, hobbies, social life, and other activities which means that committing to 20 hours of trading is not only impossible but also not necessary.
So you need to find the right timeframe that works for your lifestyle and make sure how many hours a day you can commit to. Managing your trading time properly that you are managing the risk too because time is often a highly valuable component to trading happiness and success.
4. Avoid weekend gaps
Despite the fact that forex trading retailers can make speculations on the market 5 days a week, in fact, the forex market is not exactly closing doors from Friday afternoon to Monday morning, the charts around the world don’t freeze during the weekend, and the prices are still moving based on what happens during the weekend.
Some weekends there is nothing important happening, however, sometimes there are important events and changes during the weekend which usually cause the dramatic movement of the prices until the day there are visible after the weekend that is called gaps.
With so many forex trading tactics and strategies, some traders prefer to trade with these gaps and even if you are not planning to do so, weekend gaps often can run between your intended stop loss or profit target and increase the risk of a larger loss. Despite not being common, weekend gaps can catch you off guard and if you are following an effective risk management strategy you would like to avoid them.
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5. Watch the news
News events, announcements, published reports, etc. can be a real helping hand for people who are looking for good risk management. Some of the most important news announcements you would like to look for are events like employment, central bank decisions, inflation reports, and others that can create abnormally large moves on the forex market. Unless trading with gaps that happen after those major events is not part of your strategy, most of the forex traders prefer to make more risk-conscious decisions when after such big news releases.
6. Don’t risk what you can’t afford to lose
Never investing more than you can afford and stomach losing is one of the most fundamental doctrines of forex trading. It makes a lot of sense that you wouldn’t put so much money into your account so that you don’t feel comfortable carrying out with your day-to-day life in case you lose them all. Trading is challenging and often risky and there is no point in risking your well-being, happiness, and security by putting all of your savings on one or more trades. Make sure to invest in a way that is consistent and mindful depending on your savings and the capital at disposal you can afford.
7. Stick to the plan
Succeeding in the forex market and effective risk management involves sticking to your forex plan and being able to plan ahead in general. Diving into forex trading without preparation increases the risk of you experiencing a major loss. You need to plan what your goals are and how you are planning to achieve your milestones.
A trading plan in forex is no different than any other basic to-do list and it should outline the trading activities you are planning to undertake and your strategies. The main idea here is developing a set of rules you are going to stick to with consistency and commitment when making trades and decisions.
A forex trading plan will help you analyse the market better, prevent you from making rash decisions and trade with emotions such as fear and greed, prevent you from making rookie mistakes, and help you in evaluating your wins and losses.
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Making sure that you follow all these 7 steps of risk management will not make you a successful forex trader who enjoys a great profit with every trade and decision taken. There are many other factors that will affect your success as a trader and whether or not you will be able to achieve the profit you are targeting. However, risk management and taking a proactive role in keeping the risk in trading as low as you feel comfortable with in a good way to tilt the odds in your favour and increase your chances of success in a long run.
If you want to learn more about forex trading you can check out the archive of interesting and helpful articles available on Trading Education’s website here and enrol on our high quality and free forex trading course here.