Forex Trading Risk Management: Do you know most new traders do not speculate over the foreign exchange prices? They gamble! Yes, their predictions don’t have any logic and reasons. If they think the price would go up, they open the position. What worse? They, without a second thought, invest almost all of their account balance upon it because obviously, the prices would go up, as per them. It is the most common scenario with anyone starting online forex trading or any market trade. But wait a minute! What’s missing here?
Risk management is another strategy to protect you from sudden changes in the price. The sudden changes could be because of anything. There are a hell lot of factors. Inflation, catastrophes, change in rules, system, political party, agreements between forex trading nations, etc. are some of them.
Many inexperienced traders debate on the need for risk management in the forex market. But! Wait, you know what? The Forex market needs it the most.
Remember, you can have the best trading strategy or best trading platform, but without a risk management plan, these are not worthy.
Forex assets are the most vulnerable to these kinds of factors. It gets affected even by bad news and events happening. Thus, it becomes crucial to have a plan in your mind to mitigate the risk. There are plethoras of ways. Here in this article, we would discuss some basic but best forex trading risk management tips. Every successful trader knows them already, and if you want to be one, then note them.
Online Forex Trading Risk Management Tips for Newbies
1. Use Stop Loss
Stop-loss is a fantastic feature to protect your portfolio from significant losses. It is an already predicted price at which your asset would be sold automatically. For instance, you are trading at $40,000, and you do not want a loss of more than 5%. Then, you will set a stop-loss price on your trade, and if the asset’s price falls on stop loss, then it would be automatically sold. Remember, stop loss is just a price and failure on falling on that exact price can also create disruptions.
For instance, you are currently trading stock at $40 and set a stop loss at $35.00. Now, assume it doesn’t fall on $35. Instead, it moves from a price point of $35.12 to $34.96 directly. Then, in this situation, your stop loss did nothing because of that price gap.
However, a stop loss is a fundamental online forex trading tool. Trading without a stop loss is like jumping out of a plane without a parachute. We also personally would suggest using it.
Forex is one of the largest 24-hour operating markets in the world. It could be an advantage and a disadvantage both. How? Just read!
The 24-hour time frame allows the trader flexibility to trade foreign currency, any time, and also prevents sudden changes in prices. However, it could also put traders in more stress, and they might even lose a great opportunity because of unavailability at that time.
One way to avoid this loss is to have an automated algorithm which would automatically sell your currency at a specific price. It is very much like the stop-loss tool, but creating or purchasing this kind of tool would not be a viable choice for every trader. We can just suggest you, determine a fixed timing for online forex trading and apart from that just forget every change in price.
3. Know What You Can Afford
A trader should be just investing the amount which he can afford to lose. For instance, if you have only $1,000 in your hand, then you can’t spend all of this on trading only. It is the most fundamental tip which every trader should keep in mind. But, what happens is opposite. It is the most commonly skipped rule, especially beginners. They think that this rule would not apply to them.
The rule has some logic behind it too. First, the online forex trading market is too volatile and unpredictable. Second, even a slight change in the price would affect your emotions to a large extent. Third, if you lose, then it would be more difficult for you to cover your losses. Many times new traders, after a fall, feel a strong temptation to invest more and cover their losses. However, the strategy should be to take a break or move rationally.
4. Knowing Forex Trading Risk Tolerance
Risk tolerance gets measured in percentages. For instance, on each trade, if you have a risk of 5%, then it means out of 100 transactions, 5 trades would possibly result in a loss. In other words, you need to lose 20 straight deals to exhaust your trading account balance completely. A new trader should keep this percentage in a reasonable range. Several factors usually decide it; some of them are age, forex trading knowledge, experience level, your objective and loss of affordability.
5. Position Sizing
Every instrument has a certain amount of win rate based upon risk, past records, etc. This win rate determines the probability of an asset’s price change (whether it would gain or lose). A trader should allocate its fund in the proportion/ratio of win rate of different assets, which he wants to trade. For instance, there are two assets in your watch list, both proliferating. However, the first one has a lesser number of swings than the second one in the price. So, it would be feasible for the trader to allocate more on the first asset than on the second.
Therefore, increase the position size on a trade when the win rate is good and vice versa.
6. Be Practical
The most common mistake beginners make while forex trading is setting unrealistic goals. They want to earn money quickly and think trading aggressively would make them rich. However, every successful trader in this world is a slow but steady earner. Setting conservative expectations is the right key here.
You should always know when to enter and exit the market, avoiding emotions like greed and fear. Feelings in a trading game can lead to bad decisions which would eventually reflect in your portfolio. Thus, being disciplined is also required here.
7. Manage Your Leverage
The new margin feature in the forex trading market allows the users to spend more than their actual account balance. For instance, you have $2000 in your account, and your broker offers you 40% leverage. Then, you can trade foreign currency for $5000 with your $2000 only.
Now, suppose the price of the asset moves up by 10%, then you would gain $500, instead of $200. Most traders use leverage to maximize their gains. However, if the price drops, then your losses would also be more than the actual ones. Therefore, it is always recommended to use reasonable leverage while forex trading, especially to new traders, as it can significantly affect their performance.
8. Understand Correlations
Foreign exchange market requires every trader to buy/sell in currency pairs. Every currency has some relation between them. The only difference is some have strong relationships between each other, while some rarely affect each other. It’s also worth noting that any currency pair would have either a positive or negative correlation between each other.
A positive relationship between a currency pair means if the price of one currency goes up, then the other would also follow the path and vice versa.
A rational trader avoids situations like buying several currency pairs that cancel out each other. They also are wary of currencies which easily get affected by the commodities market. It holds true for nations who depend upon commodity trading too much. For instance, a lot of revenue for gulf countries comes from oil exports.
9. Diversify: “Don’t ever put all your eggs in only one basket.”- Warren Buffet
This trading advice by the legend himself is a golden tip for many traders, and you are no different. It would protect you from high losses. Now, many people argue that this reduces profits too, but remember, forex trading is not a one day game. You need to be patient and consistent to be successful. Otherwise, the list is no less for unsuccessful aggressive traders.
You should also remember that this applies to every market. Also, don’t spend all on forex or commodity or the stock market. Instead, have a balanced approach. Mark our words; you would be in profit for longer.
We have seen more traders falling into the trap than you!
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Note: Do not take this tip as an extra! It is as important as the above ones.
Plan for the worst and control your emotions. People often fail to recognize the importance of planning. They are impractically optimistic about their predictions. Forex market is full of uncertainty and being patient and calm can be the best tools for any trader.
Also, have a back-up idea in your mind if the situation gets worse.
We are done now from our side, but before wrapping things up, let’s quickly analyze the above tips and how you can implement them.
How To Manage Forex Trading Risk
Volatility presents within the forex markets that represent a wide range of opportunity to get profits, but it would come with added risks. Forex Trading Risk Management enables to implement a set of measures to ensure the negative impact is manageable in the Forex trade.
- Understand Forex market
- Make the best trading plan
- Use limits & stops
- Control your emotions
- Keep your eye on events as well as news
Analysis & Conclusion – Forex Trading Risk Management
In forex trading, half the game depends upon risk management. The remaining game depends upon the trader’s predictions, experience, age, goals, and many more. But, if a trader would be unable to manage his portfolio risk effectively, then he has already lost the battle. Limiting or maintaining it can keep you in this game for long, and you would survive the hardest of storms smoothly.
Wait! Does this mean by following the above tips, we are ensuring you a successful trade foreign currency plan? Definitely Not!!!
Remember we told you about the other half. Yes, that matters too! As you will start trading, you’ll become familiar with stocks and its working. You will eventually develop your strategy, which works best for you.
Talking about these tips, while some tips should be on your must follow list, you can skip some of them also if you feel so. Tips like the use of stop-loss, diversifying portfolio, being realistic, and risk tolerance should not be skipped at any cost, according to us!