When it comes to investing, risk management comprises the need to keep your risk under control. The more controlled your risk is, the more yielding you can be when flexibility is called for. Since Forex trading is all about opportunity, traders need to be able to act quickly when those occasions arise. Limiting your risk enables you to continue trading when things do not go as anticipated and places you in a position where you are always ready to move.
Using proper risk management techniques can make the difference between your becoming a Forex trader with consistent profitable trades or one that muddles along never knowing if and when his trades will succeed.
Risk Management Techniques
There are several risk management techniques available to help keep your losses to a minimum.
The first risk management technique is to mentally select a point where you feel you will be entering a risky situation. This is the point where you will accept your potential loss and if you feel fine with it, you can continue with the trade or pull out. If you know that the loss will be too great to bear, then you must not take the trade or else you will be severely stressed and unable to be objective as your trade progresses.
In figuring out the odds in your favour, it is important to designate a mental line which will be your exit point if the market trades to that level. The difference between this back-out point and where you enter the market is your risk. Psychologically, you must accept this risk upfront before you even take the trade. If you believe you can accept the potential loss, and you are fine with it, then you can consider the trade further. If you don’t see yourself being able to bear the loss, you must pull out then and there.
The next risk factor is liquidity which questions whether or not there are a sufficient number of buyers and sellers at current prices to easily and efficiently take your trade. Liquidity in Forex markets is not a problem. This liquidity is known as market liquidity and in the spot cash Forex market, it accounts for a trading volume of $3 trillion per day.
This liquidity is not necessarily available to all brokers and is not the same in all currency pairs. It is actually the broker liquidity that will affect you as a trader as it is on him that you rely to hold your account and execute your trades accordingly.
Risk per Trade
Another risk management technique is to accurately determine how much trading capital you have available. Risk per trade should always be a small percentage of your total capital. A good starting percentage could be 2% of your available trading capital
Using leverage correctly and not excessively is another risk management technique. Don’t be carried away with the large leverage numbers a broker will offer you. Although one of the big benefits of trading the spot forex markets is the availability of high leverage, keep in mind that leverage goes two ways. If you are leveraged and you make a profit, your returns are magnified very quickly but, in the converse, losses will erode your account just as quickly too.
Of all the risks inherent in a trade, the hardest risk to manage and by far the most common risk blamed for trader loss is the bad habit patterns of the trader himself. The solution to this is to hone your good habits and not let your ego get in the way of making the right decisions.