Risk management is the most important tool for Forex traders also its the less tool used by traders
Because many Forex traders dont know how to control the risk
More risk you take, more reward you will make
There is a positive correlation between the risk you take and the reward you will make
Look:
Its absolutely true that No risk, No reward
But, you should control these risk to make a stable reward
Because if you do not manage your risk you are going to lose your money
Not only in the Forex market but also in other financial markets
Forex risk can be discussed in 3 major points:
- Exposure:
its how many lots you risk when you open a position?
If you buy or sell 20 lots you will assume more risk than buying or selling just one or two lots
- Duration:
The more time you open a position, the more you could confront dangerous moments and high risks
The quicker you close a position, more you enhance your chances tominimize risks
- Frequency:
The time you enter a trade:
What is the level of volatility of the market?
Is the market high or low volatile?
The risk can be significant when the market is high volatile
95% of Forex traders fail because they dont manage risk
Or they misunderstand the concepts of Forex risk management
Many successful Forex traders use every type of Forex trading techniques, codex and tools:
- Fundamental analysis
- Fibonacci
- Candlesticks charts
- Patterns
- Elliot Waves
etc
Everyone use the techniques that get to him results in the market
But they have all of them a feature in common:
They share the characteristic of good understanding of risk management
Currency trading is not about making money, its about learning how to not lose money
Step #1
- Dont trade big lots:
You are probably excited to make tons of money from Forex trading
Emotions may influence you to trade big lots, this why you should beat your emotions
And start taking decisions according to your trading strategy
You should trade small lots especially if you are beginner at Forex trading
Or if you have not a significant capital to invest
Step #2
- Dont take large risk:
Taking large risk means that you are going to lose your money quickly
The market is not merciful
Even if you won an amount of significant money at the beginning
Make sure that large gains at the beginning means large exposure at the end
Dont take big risks until you build enough capital
Just climb stages with caution
Its not good to make a profit of 500% the first month
Then lose all of your money the second month
Turn up the volume slowly
Step #3
- Do not enter a trade if you are in doubt:
All of the traders must follow a system or a strategy to trade pairs of currencies
If you just make random trades or you trade using a weak strategy
Then you are not yet a trader
For example:
If according to your Forex trading strategy you find that you can go long (Buy a currency) Now
Then do what your system told you to do
But if you are not sure or you are in doubt
Do not enter the trade
Otherwise, if you have entered a trade and it doesnt behave like expected
Or you are confused
Get out immediately from the market!
Step #4
- Do not over trade:
You need to make one or two trades per a day
one profitable trade is greater than doing ten loses trades a day
You have to limit your trades in order to limit your losses
Grab just the profitable opportunities
And dont let emotions control you
There is a powerful tool to limit your trades that I use every day I trade currencies
I have talked previously about it in my guide about traders psychology and how to beat emotions with simple steps
Its the Daily trading plan
Take a paper and answer the following questions to make your daily trading plan:
- What pair are you going to trade today?
- What time are you going to trade this pair?
- What techniques are you going to use to trade that currency?
- How did you feel when you open positions?
- What happen while you are in the positions[feelings]?
- Why did you close the position?
- Is there any news that can affect your trades today?
- What contingencies are you expecting today?
All of those questions must be answered every day you open your platform to trade
Trading Forex is about quality, not quantity
When you get enough experience then you can open more trades per a day.
Step #5
- Place a stop loss every time you open a position:
Every trade you make, you must set a stop loss for it
The stop loss protects you to not lose all of your money when the Forex market reverses against you
Placing a stop loss limit your losses
The simple way to set your stop loss is to put it at the point that the price can not reach
Imagine if you open a buy position without setting a stop loss
Suddenly the market goes down for 300 pips because of the last announcement from the European central bank
You will lose eventually 300 pips..
Now
Think if you have used a stop loss of 30 pips
You are going to lose 30 pips instead of losing 300 pips
You just saved 270 pips
A stop loss is simply how much you want to risk (your risk tolerance) to make the profit
A good Forex trading strategy allow you to gain more than you risk (Reward/Risk ≥ 2)
Did you know how to place a stop loss?
Look:
its simple
To define a stop loss, you can use several tools
Here are the 5 most powerful ways to define stop loss points:
- Support and resistance lines:
If you open a short position (Sell order) then you can set the last resistance line as a stop loss.
Otherwise, if you open a long position (buy order), you can set the last support as a stop loss.
- Fibonacci:
If you trade in an uptrend market you are going to see that the price moves back down for multiple times at Fibonacci 50% and 61,8% levels
50% and 61,8% Fibonacci levels are considered as rebound points (Supports and resistances) where the price probably could reverse its direction
So ..
If you decide to buy a currency pair in an upward trend then set the stop loss just below the 61,8% Fibonacci level
- Moving averages:
You can use also the moving average indicator
The best one is 200 MA that allow you to find the best place to set your stop loss (look at the image).
To simplify the use of 200 MA consider it as a support and resistance line..
- Candlestick patterns:
If the chart displayed a reversal candle like a hammer, you need to place the stop loss just below the hammer
- Trend lines:
You can also choose to set your stop losses according to the trend lines
Probably always you hear that Trend is your friend .
Its true
Following trends is the best way to find trading opportunities and set your stop losses
You just need to set the stop loss at the point where the price matched the trend line..
Like at the image below:
Step #6
- Risk a specific % percentage of your account value on every trade you make:
In order limit the risk on every trade you make
You need to risk 1-2% of your account value
For example:
Lets suppose that you have an account of $5000
You should risk no more than $50 to $100 per a single trade
Lets say that your Forex trading strategy show you a trading opportunity to gain 100 pips
And you have found that the stop loss must be 30 pips
[Remember that you have to risk no more than $50-$100]
Lets do the math:
Risk = 30 pips = $100[2% of the account value]
> $100/30 pips = $3,33 per one pip
> So you need to set for 1 pip, 3,33 dollars
Your profit, if you convert it to dollars will be: 100 pips x 3,33 = $333
Its a reward/risk ratio of $333/$100 = 333%
Always set a reasonable stop loss that allow you to generate a reward/risk ratio of more than 200%
Look:
What I mean is that:
If you find that you must risk more than you are going to make due to the volatility effect
Search for another opportunity!
Step #7
- Reduce risk on every successful trade you make:
You can reduce the risk of a successful trade by tightening your stop
If the price moves in your favor you should tighten your stop
You can use the trailing stop feature to adjust your stop loss point easily that comes with every Forex trading platform
If you use the Meta Trader trading platform here is how to tighten your stops automatically:
You must have an open position in order to set the trailing stop
- Right click in the position.
- Select trailing stop
- adjust your stop
Step #8
- Know the myth about the win/loss ratio:
The win/loss ratio is used to rate traders
You can make money even if you have a bad win/loss ratio
Look at this comparison between trader A and trader B:
Trader A and B gains and losses:
Trader A and B win/loss ratio:
Trader A = 4/5 = 80%
Trader B = 1/5 = 20%
Trader A and B results:
Trader A = -35 points
Trader B = +51 points
Lets do the analysis:
As you look above the trader A had an excellent win/loss ratio of 80%
The trader B had a low win/loss ratio of just 20%
Despite the fact that the win/loss ratio of the trader A is greater than the trader B
The trader B make a profit of 51 points, and the trader A make a loss of 35 points
This contradiction happened because the trader B control his losses better than the trader A
Remember that:
Trading is the art to not lose money
These experience show that you can make money from the Forex market even if you loss the majority of your trades
And you can definitely lose your money even if you win the majority of your trades
It is not matter how much time you are right or you are wrong
The important thing is how much profit you make
It is not whether you are right or you are wrong thats important, but how much money you make when you are right and how much you lose when you are wrong.___Stanley Druckenmiller
Example two:
We suppose that you have an account of $10000
You decide to risk 2%
So the maximum money you will lose doing a single trade is 10000*2% = $200
Let us suppose that according to your trading system you have found that you must set a stop loss of 30 pips
$200 / 30 pips = $6,66 /pip
So you need to set an order size of $6,66 (1pip=$6,66)
What you will benefit from risk management?
We suppose those parameters:
- Account size = 10000$
- Win / loss ratio = 3 : 1
- 1 pip = 6,66 $
- Stop loss =$10000 * 2% = $200 = 30 pip ( $6,66/pip to risk )
- Targeted profit = 3 * 30 = 90 pip = $600
Despite the fact that we lost 50% of our trades
we have made around $3000 as a profit
The power of risk management is that you can control your losses easily
Step #9
- Know when to close a trade:
After you set a Win / loss ratio of 3 : 1 for example
You will logically close your trade when the price reaches your take profit
Thats true but not all of the time!
In my opinion, there are five reasons to close a position:
- Forecasting a Market change:
- For a long time, your position displays a loss ( Forex market amend its direction on three days so if your trade show a loss for more than three days, just close it )
- You have technical problems on your platform or on your computer.
- You suffer from emotional crisis.
- Bad news about the currency you trade are pending.
Step #10
- Dont go intensive:
If you sell EUR/USD and you buy GBP/EUR you must know that you have sold 2 lots of the same currency(EUR)
Be aware to not buy or sell multiple times the same currency
You just raise your chances to lose more if the market go wrong with you
I advise you to diversify your portfolio by buying and selling different pairs
Those pairs should havent any correlation between them
like buying EUR/USD and selling GBP/JPY
This help you to protect your trading from big losses
Tell me:
how do you manage risk when you trade Forex?
I think I help you understand how to manage risk when you trade forex
[I'm not a native english speaker so I'm sorry if there are any errors]
Thanks
Source: http://investoune.com/forex-risk-management/