What Is the Importance of Risk Management in Forex Trading?
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Forex trading can be a roller coaster ride for unprepared investors. But, like any other form of investment, if you have strategies in place, you could even get to turn your forex dealing into a full-time career.
One major area any forex trader needs to find out about when they learn to trade is the significance of risk management, and this is discussed in more detail below.
Learn how to trade forex
You will get to appreciate all the ins and outs of forex much quicker if you sign up for a comprehensive forex trading course, and our free trading course will soon help you learn about dealing different foreign currencies.
Forex trading can be a lot of fun for anyone making the effort to learn to trade, however, lots of people start trading and give up after experiencing one or two losses. One of the things you need to understand at the very start of your forex trading activities is that you are bound to have losses.
However, once you've mastered the art of trading you'll learn just how to mitigate your financial risks and begin to launch your own successful trading career. You can earn substantial sums of cash from successful forex trading and our useful guide to forex trading and how it works will give you a head start if you plan to start trading forex immediately.
This comprehensive guide explains all about currency pairs, forex spreads, and leverage, but doesn't go into too much detail about risk management in forex trading. That's the reason we've posted this article, to offer all our trainee forex traders bang up to the minute info on the management of risks in forex trading.
Sign up for our free course in forex trading today to find out more about this engaging investment strategy or learn more about managing the risks in your daily forex trading below.
What is risk management in forex trading?
It's recognised that up to 90% of new forex traders lose cash on their first trades and many of them will give up trading at this point.
But, forex is a massive global financial market and over $5tn is traded on exchanges on a daily basis. Traders can be active on the forex market 24 hours daily, and, what's more, you don't need to invest pots of your own cash into trading.
Plus, online forex broker commissions are competitive, making it easier to see profits from regular trades.
One of the most important learning curves for newbie forex traders is risk management, though.
Leverage in forex trades can be as much as 1000:1, meaning that for every £1 you invest into a trade your broker will add leverage of 1,000 x, so you can trade £1,000 worth of currency with your £1. Of course, different brokers work to their own rules on leverage and the current allowable amount in the UK and EU regulators state that major forex currency pairs should only be allowed 30:1 leverage. While less popular currency pairings can be leveraged up to 20:1.
Leverage allows you to invest more cash into your forex currency trades, potentially offering greater profits. However, the risks are greater. If your chosen currency loses against the paired currency you will need to cover all losses made in the trade. That's why it's important to plan your risk management strategy in advance for all forex trades.
People also read: The Ultimate Guide to Building a Forex Trading Plan
Managing your risk in forex trading
As can be seen, managing risks in forex trading can be the difference between losing a fairly large sum on your first trade or regular profitability over a longer term. When you manage forex trading risks effectively you will probably never be in the situation of losing all your cash.
Our tips on effective risk management include:
- Monitoring position sizes - Work out what percentage of your funding will be used for any trade and stick to it. So, if you have a £10,000 trading account balance (including any leverage), you may want to limit your risk by 1% or 0.5% per trade. This means you would risk a loss of £100 or £50 per trade. The other risk factor to consider is your pip risk, meaning you need to set a stop loss order at the most appropriate point.
- Stop losses - You can find out more about pips in forex trading in our knowledge base. Placing a stop loss order means the trade will close out after a specified total loss. You need to work out how many pips you are prepared to risk on any trade, ideally, this should be as close to your entry point as possible.
- Take profits - Another common mistake made by new forex traders is failing to recognise the point at which to take profits. There are strategies you can use to manage the point at which to take profits. Probably the most solution for newbie traders is to put a close position order in place to take profits at the appropriate level of resistance. Candlestick recognition and moving average crossovers are some of the other strategies used by traders, and you can find out more on our site.
- Having a trading plan - From all the above, you can see it's vital to have a trading plan in place for forex deals. It's important you don't rush into trading and perhaps risk 10% of your capital on one trade, 20% on another and so on. Because this is the way to lose all your trading capital in just a few losing trades.
- Staying disciplined - Put discipline in place with all your forex trades, this way you can build your capital slowly but surely. You may not make thousands in a couple of days, but equally, you won't lose thousands either!
Don't miss: How Much Money Can You Make Trading Forex?
All factors of risk management
Our brief risk management guide above really just scratches the surface of risk management for forex trading.
You would be well advised to register for our free forex trading course to learn more.
Once you've mastered the disciplines noted above, one other major risk management factor for all forex traders is to limit the use of leverage to levels that are more comfortable if losses are made. This way you'll be sure to hold onto your trading capital for a longer period of time.
And, finally, risk management in forex trading is probably the most important lesson to learn. If you understand all the risks you face when forex trading, and plan your deals accordingly, you will have lots more trading fun!
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