Beginners Guide

Forex Risk Management


Forex Risk Management

Now, we are going to get to a part that is very important in your career – Forex Risk management. You should never forget what we are going to discuss in this section. It is said that more than 90%  traders fail in the market. While there are a lot of reasons for that, the most important reason is poor risk management.

Controlling The Lot Size

As we explained earlier, a higher lot means more money. If you choose the standard lot size of 1, a profit of 30 pips will give you $300 whereas the same profit with lot 0.01 will give you just $3. So, does it mean you should choose a lot size that is as high as possible? No, Not at all! That is the biggest mistake you can do in Forex.

In every trade you place, you are taking a risk. When you place a trade, you are essentially saying that you are ready to lose the money that you are risking. If the same trade with the standard lot size resulted in losing 30 pips, you will lose $300. That doesn’t sound good. There are many traders who choose a capital as low as $300. For them, this means just wiping the whole account away.

So, there is a general rule in Forex followed by most of the traders. Here it is: Never risk more than 2% of your capital.

You may use the best strategy in the whole world; You may have the knowledge of technicals and fundamentals at your fingertips; But if you don’t follow proper forex risk management, you will still fail. Your survival in Forex depends on risk management.

Using Stop Loss

Forex Risk management and calculation

Another huge mistake to make is not trading without a stop loss. Never do that, that is the worst blunder… A stop-loss is set to control the losses in case the price moves against your prediction.

You may be thinking this way: “Why should I worry about stop loss? Even if the currency pair moves against the prediction, the movement may reverse at any time and go in the desired direction”. No, you are wrong. If you choose any chart and look at the history, you will see that it is not correct. Sometimes, a currency pair may move in one direction for months, or even years. No one can make an accurate prediction regarding this. And, a pair may change the direction at any time, regardless of all the analysis you do about it suggesting you the opposite.

Also, it is common for some traders to keep moving the stop loss out of temptation. Don’t do that… Once you set a stop loss, stick with it.

Choosing A Time Frame

A trader can choose to trade at different time frames. As we already saw there are various time frames available starting from 1-minute time frame to monthly time frame. Trading very short time frames like 1 minute or 5 minutes are known as scalping. A short-term trade focuses on 15 minutes to 4 hour time frames. A long-term trade may last for a few days to even months.

Scalping Explained

Simply put, when you hold a trade for a few seconds to a few minutes, it is called scalping. You can be done with a trade in the duration when someone goes to the restroom and comes back.

If you prefer grabbing small profits trading multiple times a day instead of holding on to one or two trades for the entire day in order to get larger profits in each of them, then you can go for scalping.

But you have to be paying a lot of attention to what is going on and you have to be really glued to the charts. Concentration and quick thinking are necessary to become a successful scalper.

There are a lot of rules that you need to learn which are specific for scalping. It is not for everyone and has its own pros and cons. If you like the idea, then try trading in a demo account and see if you can really do it.

Trading Longer Time Frames

There are a few things to keep in mind when you trade a longer time frame. First, you will be placing bigger stop losses when trading longer time frames. This means that you would have to have a bigger account.

But you don’t have to keep watching the market when it comes to long-term trading. Long-term traders choose weekly and even monthly time frames which give them the liberty of not having to watch the markets intraday. Also, there will be fewer transactions overall which means you will have to spend less money on paying the spread.

Another advantage in choosing longer time frames is that you get more time to think. When it comes to decision making, people struggle a lot due to overwhelming emotions. Emotions like greed, frustration, fear, and overconfidence can cloud your cognition and act as a huge obstacle in trading.

Technical analysis in longer time frames also has better accuracy. This is because longer time frames usually don’t have more noise and it is easy to make predictions. By looking at a chart in a longer time frame, you get a clear picture of what is going on in the market.

But this is not to say that there are no downsides. You need to have a bigger account and have a lot of patience. There might be a lot of losing months that you have to go through.

Best Time Frames To Trade

Usually, it depends on how long you want to hold the trade. But if you are a beginner, it is recommended to use longer time frames (1 day or 4 hours). You may be tempted to use short time frames to get quick profits, but resist the temptation.

If you try to be a scalper and use shorter time frames right away, you will find it more difficult to get profit and develop a strategy. Longer time frames are easier to work with for beginners.

Once you get more experienced, you can select the time frames depending on how long you want to be in the trade and your personality. There are pros and cons to each type of time frame.