Do you know that your success in Forex trading depends a lot on how well you manage your risk? Once you know the best tips to manage your risks, you can limit your losses to a great extent.
Risk is a part of life on this planet. At every important step in life, you need to take risks. Hellen Keller said, “Life is either a daring adventure or nothing at all.” This is true for both animals and humans.
Even wiser is the quote “Don’t be too timid and squeamish about your actions. All life is an experiment. The more experiments you make, the better.” by Ralph Waldo Emerson.
Forex trading needs a certain amount of courage, as it involves a lot of risks. Since it is too risky, learning risk management and applying a good risk management strategy is very important too. In this post, we will see some useful tips for risk management.
1. Only risk the money you can afford to lose
When it comes to risk management, the first thing to understand is the amount of risk involved in Forex trading. It is not the kind of job where you get paid by hours. It is a serious business that involves a lot of risks.
Are you aware of how risky Forex is and how frequently losses happen in trading? If your answer is yes, then you also know that you can lose your whole capital on a single day itself, if you are not careful enough.
So, an important rule in risk management is to set aside the amount you can afford to lose as a capital. Also, make sure that you only risk the amount you can afford to lose on each trade.
If you are using the money that you need for living and investing that as a capital, it is not a good idea. If you blow up your account just in case, you will be in a lot of trouble.
Many people make the mistake of risking too much as a new trader and spend the rest of their lives in recovering the money that they lost. Make sure you don’t repeat the same mistake!
2. Deciding your risk tolerance is critical in risk management
Risk handling involves a lot of stress. Everyone has a certain tolerance level when it comes to risk-taking.
People tolerate uncertainty to some extent, but it becomes too difficult to bear after a while. So ask yourself; how much risk can you tolerate?
You need to come up with the right answer to this question if you want to practice effective risk management. This is something that you have to decide before you start trading.
Risk tolerance varies with age, income and financial goals. You can tolerate a lot of risks if you have a lot of money.
If you have a million dollars in the bank account, would you lose your sleep over losing $1000? Probably not! But losing $1000 when you have only $2000 in your bank account is terrible.
Risk tolerance is also related to your ability to handle stress and negative emotions. It may improve by experience. As you become a better trader, you may be able to tolerate more risk.
3. Don’t risk more than 2% of your capital
Forex trading needs a lot of planning. When it comes to risk management, you have to answer a lot of questions as a part of making a wise plan or a powerful strategy.
One of those questions would be, ‘how much do I risk per trade?’. That depends on how much capital you have.
It is a good practice not to risk more than 2% of your capital at any point of time. In fact, it is better not to risk more than 1% if you are a new trader.
Choosing a higher trade volume certainly gives more profit if the trade goes as per your expectations. But you will also end up losing huge money if the trade doesn’t go well.
If you risk too much and face too many losses, you will blow up your account very quickly. This is exactly what happens to many new traders who start trading without learning proper risk management.
In trading, winning trades and losing trades are randomly distributed. You don’t win or lose the same amount of money every day. Sometimes there are losing streaks that quickly reduce your account balance. Only if your risk per trade is low enough, you can handle such losses.
4. Control your leverage
Leverage is higher in the forex market than in stocks. It makes the Forex market very attractive for traders.
Leverage lets you borrow money from your broker so that you can control a huge amount of money with a small initial margin requirement. Leverage has the potential to increase your profits or losses by the same magnitude.
In the Forex market, leverage is usually as high as 100:1. What does that mean? With just $1000 in your account, you can actually trade up to $100,000 in value.
This means while you can get a good profit, you may also lose a lot of money. It is a double-edged sword.
But you don’t have to be scared about it. Once you know how to manage leverage, you can use it to your advantage.
It has to be handled carefully though, just like handling a very sharp instrument. So be careful that you don’t use excessive leverage. High leverage may seem very attractive, but it is very dangerous.
5. Use Stop Losses
An important risk management tip is to use stop losses for every trade that you place. So, it is something that needs to be set for every trade you place, without fail.
A stop-loss acts as a shield to protect you from unexpected shifts in the Forex market. It helps you to control how much money you would lose if the trade goes against you.
Trading without a stop loss is very dangerous. Sometimes the market may move too fast in the direction against your trade and that may result in a huge loss.
Pick and choose a good risk-reward ratio that works for you. Decide how many pips you want to allocate for stop-loss based on your capital.
You can also move the stop loss to break-even to lock the profit and avoid losses. But do not move your stop loss in a losing trade! That is a bad idea. You may hope that the price may reverse before getting stopped out, but you will end up losing more money if it goes wrong.
An effective risk management strategy involves using the stop loss efficiently to control how much money you want to risk. So always use a stop loss for all your trades.