Top risk management strategies in forex trading
Risk management is one of the most overlooked and misunderstood concepts of forex trading.
If you fail to develop strict risk management strategies in your forex trading, you’ll set yourself up to lose more funds than you need to.
You’ll become frustrated, make impulsive decisions, violate your plan and make the whole FX trading process more difficult than it should be.
Here we’ll offer some tips to develop top risk management strategies, including how to control the risk per trade and overall market risk, to ensure you stick to your trading plan.
How much money do I need to start forex trading?
Many credible forex brokers allow you to open a forex trading account for as little as $200. With this micro account, you can still access the market through highly respected platforms such as MetaTrader’s MT4. The spreads you get quoted should also be competitive.
You should trade your first account amount with the same level of attention and respect as a large account. If the method and strategy you developed work best on one major forex currency pair only and your risk per trade is a 0.5% account size, stick to these rules.
If you get tempted to up the risk because you consider the sum insignificant, you need to recognise that you’re facing your first test. Avoid the temptation to increase the risk until your system (method/strategy) is proven. If you’re not profitable with $200, your system won’t suddenly work with a $20,000 account.
Set a risk v reward ratio
Setting a risk v reward ratio on every trade you take is a risk management technique many experienced traders use. For instance, if you decide to risk $10 on a transaction, you’ll aim for $30 if applying a 1:3 risk versus reward ratio.
When you work out the probability possibilities of R v R, you can see how the phenomenon can work in your favour.
Consider this. You’re risking $10 to make $30. So, if you only have three successful trades out of ten, you should (in theory) bank profit.
- You’d lose seven trades at $10, a loss of $70.
- But your three successful transactions would make a profit of $90.
- Therefore, you’d be $20 in profit on the ten trades.
Now 1:3 could be considered overly ambitious and unrealistic for certain trading styles, but not for perhaps swing trading, one of the most popular forex trading styles.
You can expand this risk v reward strategy to understand how even 1:1 can be profitable. For example, if you win 60% of the time, perhaps losing 4 out of 10 trades, you’ll still be in profit even with a 1:1 fire and forget strategy. Such tight money management strategies are popular amongst day traders.
Use stops and limits
Most experienced and successful traders know the precise risk they take when they click the mouse and enter the market. Whether it’s $10 or $1,000, they know how much money they can lose and what percentage of their account the sum represents.
They limit their risk by using a stop-loss order. This simple tool stops you from losing excessive amounts. For instance, you might have a $1,000 account and decide to risk no more than 1% or $10 on each trade. You set your stop loss at the point where you can’t lose more than $10 if your stop gets triggered.
Use position size calculators
A helpful tool known as a position size or pip size calculator can help you figure out what risk per pip you need to take. For example, if your stop gets set ten pips away from the current price, you might risk $1 per pip. But if it’s twenty pips away, then your risk per pip is $0.50.
Limit orders
Take profit limit orders also help you manage your risk, particularly if you’re looking to apply a risk v reward strategy as mentioned above. If you hit your 1:3 target, then why stay in the market hoping to squeeze out every dollar’s worth of profit? You’ve achieved your goal, so close the trade, bank the profit and move onto the next opportunity.
Pay attention to market news and economic data
An economic calendar is a handy tool for managing risk. You can study the calendar to know which events are most likely to move the markets in the currency pairs you’re trading. Here’s a scenario to consider.
If you have a live EUR/USD trade and it’s in profit, you might want to think about adjusting your stop, taking some profit off the table, or altering your targets if the Federal Reserve gets set to make an interest rate decision on the day.
The careful adjustments of your live trade/s might prevent a winning position from turning into a loser. You could consider this a precautionary measure as the news is published and revert to your previous stop and limit once the event passes.
Select the currency pairs you trade carefully
Forex currency pairs are not all created equal. The spreads you pay on the major currency pairs are consistently lower than spreads quoted on the minor and exotic currency pairs. The volume of trading determines spread quotes.
EUR/USD is the most traded pair on the FX market, so you’d expect it to have the best spreads and the fills and slippage to be more favourable.
Whereas, if you trade USD/TRY because the Turkish lira is a hot topic occasionally, you might suffer from considerable changes in trading conditions. The spreads might suddenly widen, and slippage filling you at prices some distance away from the quotes.
But the spread cost is just one consideration concerning risk management strategies. It also would help if you considered the correlations between specific currency pairs and how volatile they can be.
Because both subjects also affect your bottom-line profit, they’re vital components for your overall risk and money management.
Building your forex trading plan
Stop losses orders, limit orders, position size calculations, what currency pairs you trade, how much risk per trade, when to buy and sell, on what platform and through which execution-only broker are all critical decisions built into your trading plan. All these factors help to support your overall risk management strategy.
The plan is your blueprint to success, and it doesn’t have to be an encyclopaedia. It can be a simple series of notes, which gradually expands on the seven topics mentioned above during your trading career.
Learn what leverage and margin are and how to use them
The best forex traders also understand the concepts of leverage and margin. Both factors will have a considerable effect on your trading outcomes. If you apply too much leverage and trade close to your margin limits, you can quickly experience potentially profitable trades going bad as your broker restricts your ability to trade.
If leverage and margin become issues in your trading strategy, you need to consider changing your method/strategy.
Experimentation reveals which R v R strategies suit your overall technique
In conclusion, there is no one size fits all risk management strategy in forex trading. An acceptable and successful risk per trade must be proportionate to the size of your account, the style of trading you use and the method and overall technique you employ.
It’s up to you to experiment with various R v R ratios to find suitable risk management strategies that fit your trading plan, containing all the previously mentioned factors.
It would be best if you didn’t rush into this experimentation. Use a small account initially or perhaps a demo account until you become familiar and comfortable with the phenomena of R v R and the impact it can have on your trading profits.
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