Although forex trading has the potential to be very profitable, there is also a risk of financial loss. Implement these 10 forex risk management strategies early enough before starting a forex trade—you should have some form of strategy in place from the very beginning if you want to avoid ever suffering an irreversible loss on your investment in the financial markets due to inadequate planning or lack thereof!
A trader’s first priority is to always remain competitive, regardless of the foreign exchange risk. Don’t ignore this one because it will help to ensure your longevity: a strong foreign currency strategy, restraint with regard to financial risk exposure, and technical analysis of the fine print in the financial statements.
What is risk management in forex trade?
During the learning period, your purpose is to maintain positive cash flows, limit losses, and seek reasonable risk settings. When you decide what it means from a fundamental analysis perspective, this will also help you build a foundation for it.!
The more experienced trader understands how crucial it is to avoid danger, what forex risks are and unexpected currency exchange rate fluctuations, as well as the temptation of digging unnecessarily deep holes or getting destroyed by them. Even if your approach is effective, you could not be following the guidelines for controlling risks, which is preventing you from becoming a more successful investor.
Forex trading is a high-risk endeavor. However, with the right information and strategy, you may effectively eliminate your economic risk. It is important you implement these forex risk management strategies before you move from a Demo account to a Live Account. Here are a few examples.
#1 Build a good trading plan
In this volatile market, having a trading strategy can mean the difference between success and failure. Your decision-making tool should provide answers to crucial issues like what, when, why, and how much you should trade.
It’s critical to choose a plan that works with your personality and situation. Reviewing various trading methods could be useful before launching your own. Just make sure to keep in mind their goals and frame of mind and refrain from replicating them exactly.
Keeping a trading journal is an excellent way to keep track of everything that happens when you trade, from entry and exit points to your emotional state.
#2 Only trade money you don’t need
Among the top 3 forex risk management strategies, you should never put more in danger than what is in your bank account. Remember the first rule of forex trading: only invest money in trades if you can afford to lose it all. You can think it won’t happen to you.
If trading were like casino gambling, you wouldn’t bring all of your cash there to bet on black, would you? It’s the same with trading; don’t expose yourself to undue market risk by spending funds that you depend on to support yourself.
Both because it’s possible to lose all of your trading money and because doing so will put you under more pressure and emotional stress, which will impair your ability to make rational decisions and increase the likelihood that you’ll make mistakes.
Given the turbulence of the foreign exchange markets, it is preferable to trade “conservative sums” from your available funds. Trading is sadly not for you if you can’t afford to lose your trading capital.
#3 Always use stop-loss and limit orders
Protecting your downside is plain sense and the third strategy in your forex risk management.
Because the foreign exchange market is notoriously volatile, it is essential to pick your entry and exit points prior to initiating a transaction. Orders instruct your broker to execute a trade when the price of the underlying market reaches a specified level. Here is a refresher on the operation of stop and limit orders:
- If the market moves against you, stop orders will immediately close your position. There is, however, no assurance against slippage.
- When the price reaches your selected level, limit orders will close your position and follow your profit objective.
You can leave your trading screen with a better frame of mind knowing that there is some security in place and that you have implemented some forex trading strategies.
You may sense-check the deal versus your trading plan using this approach.
#4 Trailing stop loss
This strategy involves manually adjusting the stop-loss on a trade when the value of the holdings grows. For example, if you make a trade with a stop-loss and the value of the currency pair climbs by 2%, you can choose to place a trailing stop-loss at a 1.8% profit, thereby locking in a portion of the profit while enabling the position to continue rising in value. You may continue to increase your stop-loss as the position’s value rises to maximize potential profits and reduce risk.
Accepting a blow can be challenging, but a stop-loss essentially means learning to roll with the punches. It is a crucial component of any risk management plan.
#5 Customize your contracts
There are countless trading methodologies that can be used. While some trading strategies need you to employ a very particular stop loss and profit objective on each transaction you make, others have a much wider range of requirements. For instance, it would be simple to determine how many contracts you might need to enter to attain your target outcome if you exclusively trade the EUR/USD and your trading strategy asks for a 20-pip stop loss on each trade. Calculating how many contracts to enter can be a little challenging for strategies that differ in the size of stops or even the traded instrument.
Customizing your position sizes is one of the simplest ways to ensure that you are putting as little money at risk on each transaction as possible. A micro lot is 10,000 units, but a regular lot in a currency trade is 100,000 units, which corresponds to £10/pip on the EUR/USD if you are using the USD as your base currency.
Standard lots would prevent you from trading with a risk of £15 per pip on a EUR/USD trade, forcing you to undertake trades with unfavorable risk levels. However, mini and micro-lots would enable you to trade at your own risk level. A similar argument might be made if you wished to risk £12.50 for each pip on a trade; standard and mini lots will not help you achieve your desired outcome, but micro-lots might.
Having the freedom to take calculated risks at the appropriate times could be crucial to your trading success.
#6 Think about your risk tolerance
Everyone who wants to trade in any market must make their own decision. Most trading instructors will utilize percentages such as 1%, 2%, etc. when discussing risk management, which is one of the most crucial parts of good trading but is often overlooked.
Up to 5% of the total value of your account may be at risk in any given transaction, though your level of comfort with these quantities will rely heavily on your level of experience. Since novice traders are typically less confident in their abilities owing to a lack of experience and unfamiliarity with trading in general or a new method, it makes sense to employ the lower percentage risk levels for them.
As you become more accustomed to your method, you may feel compelled to boost your percentage, but be careful not to go too far. Even if the objective is to generate a profit or maintain sufficient funds for the next trade, trading strategies can result in a string of losses.
If your trading plan calls for making one trade per day on average, risking 10% of your starting monthly amount on each trade, it would theoretically only take 10 consecutive losing trades to completely empty your account. So even if you are a skilled trader, it doesn’t make much sense to risk so much on one trade.
However, if you risked 2% on each trade, it would theoretically take 50 consecutive losing trades to drain your account. Do you believe it is more common to lose 50 consecutive deals or 10 in a row? funding for the following transaction.
#7 Set your risk/reward ratio to a minimum of 1:2
Your chances of long-term profitability will increase if you are aware of the risk/reward ratio (RRR). You can also make stop-loss and limit orders to safeguard your capital. The distance between your entry point and your take-profit and stop-loss orders is measured and compared using an RRR.
Your capital should reflect the risk you incur in each trade. Your objective should be to earn more money than you lose, allowing you to win overall even if certain deals fail. As part of your forex trading strategy, you should set your risk-reward ratio to assess the trade’s value.
Compare the amount of money you’re risking on an FX deal to the possible gain to determine the ratio. The risk-reward ratio, for instance, is 1:3 if the maximum possible loss (risk) on trade is £200 and the maximum possible gain is £600. Therefore, even though you were only right 30% of the time, you would have made £400 if you made ten transactions using this ratio and were successful on just three of them.
According to your risk tolerance, the risk/reward ratio is a crucial tool for setting your stop-loss and take-profit orders, and every shrewd trader should manage the downside risk.
#8 Control your risk per trade
When you’re new to trading and more likely to make mistakes than an experienced trader, you should also take into account your risk per trade as a proportion of your trading capital and set it at a prudent level.
A good starting point would be to risk no more than 1 percent of your available capital per trade. You should only risk a small portion of your trading capital on each transaction. Applying sound RRR necessitates incurring a 1% risk for a potential 3% return.
Here are the impacts of three different per-trade risk levels—1%, 2%, and 10%—on a £100,000 account balance during a 30-trade losing streak. A trader who took a 10% per trade risk lost 95.3% of their account balance, a trader who took a 2% per trade risk lost 44.3%, and a trader who took a 1% per trade risk lost 25.2%.
We’re demonstrating this to demonstrate that the higher a trader’s risk per trade, the more difficult it is to recover capital following a string of losing trades. Although a losing streak of 30 trades in a row is extremely unlikely, losing streaks do happen to all traders at some point, and you don’t want them to wipe out all of your capital, leaving you unable to recover.
#9 Keep your risk consistent as part of your forex risk management strategies
When beginners see some success, they often try to double down on their winning strategies by increasing the size of their positions. Keeping your risk consistent is essential.
If you start to feel more confident and willing to take more risks, you may start making irrational changes to how you handle your finances and other forms of risk.
You have to establish rules when developing your trading strategy in forex to determine the appropriate size for your positions. This is only the first stage in developing an effective trading strategy; now you must adhere to and carry out your trading plan!
#10 Understand and control leverage
Spot Forex, CFDs, and spread bets are the three margin products that successful traders frequently use; they are all leveraged products.
Due to margin trading, leverage refers to the ability to trade with amounts greater than your initial deposit. Only a tiny fraction of the total amount of the position you intend to open will be requested as collateral from you by your forex broker.
Leverage can quickly increase your profits, but keep in mind that it can also quickly increase your losses. This is why it’s important for you to comprehend how leverage and margin trading operate and how they affect your overall trading and success.
Forex traders are frequently persuaded to use high leverage in order to generate significant gains, but if you’re over-leveraged, one swift shift in the market or a minor error could result in an outsized loss.
Select a seasoned forex broker like Mugan Markets and the dependable MT4 trading platform to get you started on the path to success in the forex market. Create a competitive advantage by adopting a trading approach and a trading plan that lowers transaction risk in the currency markets and is intended to counteract challenging market conditions. If you wish to invest in the forex market, you can open a live account with us. Alternatively, practice trading forex in a risk-free environment with a demo account. Start right away and log in to Mugan Markets!