Everyone knows that with great risks come great rewards — but what can you do to control and reduce those risks when it comes to the foreign exchange market?
This is why forex risk management is crucial.
Where the foreign exchange market is so profitable (24 hour market, high liquidity, volatility, leverage, etc.), there are also ways in which it can quickly deplete a trading account. Forex trading is all about survival. There have been many incredible fortunes made but also many newbie traders entirely wiped out. If you’re a beginner to forex, you shouldn’t just be learning about how to succeed, you need to be learning how not to fail.
Here are a few ways to successfully manage forex risk and develop yourself as a trader…
Risk #1: Losing Control Over Leverage
The forex market offers more leverage than any other — but that also means that it can be spectacularly easy to lose control.
Having a 200:1 leveraged account means that you’re working with significantly more money than you actually have, and you need to keep in mind the fact that you don’t actually have all that cash. Otherwise you can find yourself facing the dreaded margin call and closing all of your trades off early. Your cash balance is key; regardless of how much profit and income you appear to be making, you need to pay attention to the cash in your account.
Key takeaway: Leverage is a tool, not a license to take more risks. Be conservative in your trading regardless.
Risk #2: Trading too Much of Your Account
It’s important not to have too much of your account tied up at one time.
Strategies vary; some conservative investors will only trade 5% of their available leveraged amounts, others will trade up to 25%. The most important thing is to make sure that you aren’t trading enough at any given time to put your entire account at risk. Everyone makes bad trades, but a bad trade at 90% of your account value will mean that you have only 10% leveraged to build those funds up. Again, cash is king: your cash is your agility within the market and you don’t want to risk it.
Key takeaway: Never engage in trades that exceed a certain percentage of your account. Set your percentage early and stick to it.
Risk #3: “Runaway” Trading
Runaway trading can occur for two reasons. You may have a trade that is going very well and you might be trying to take as much profit as possible; this is generally considered greedy and a recipe for disaster. You may also have a trade that is going very poorly and be hoping that it will turn around — and if it doesn’t, you’ll be out quite a bit of money.
Key takeaway: Set stop losses and take profits so that you don’t just let trades “ride.”
Risk #4: Emotionally Trading
Many traders can become emotional when their trades are not going the proper way.
It’s important to avoid emotional trading; it is never consistent and never produces reliable profits. Traders need to divorce their emotions from the process entirely and remain consistent or they won’t be able to tell whether their strategies are winning ones.
While there are some factors regarding “intuition”, intuition has to be standardized before it can become a reliable strategy. It’s easy for you to assume that you aren’t trading emotionally; you need to consider your thoughts carefully before embarking on any decisions.
Key takeaway: Always consider your emotions when trading — to make sure they aren’t having an impact.
Risk #5: Trading Similar Currency Pairs
If your strategy works on similar currency pairs, you may make the mistake of trading similar pairs, such as USD/JPY and USD/CHF at the same time. These both have USD in common, so if something occurs that impacts the USD market, you could end up with two trades that are performing very badly at the same time.
You should limit your trading; never trade the same currency in the same direction. You can trade the same currency in opposing directions if it fits in with your strategies and if it potentially hedges your bets.
Key takeaway: Use caution when trading currencies which move in similar directions.
Risk #6: Missing Trades or Inconsistently Trading
It’s very easy to miss advantageous trades when the market is operating 24 hours a day. This can lead to inconsistent trading.
Every day and every hour in the forex market tends to have a different temperament. You should be consistent regarding when you trade so that you can avoid any fairly unpredictable events. When you are trading, you need to be able to devote all of your attention to trading, rather than being potentially distracted.
Key takeaway: Set aside specific times for trading so you remain consistent.
Risk #7: Leaving Trades to Ride
Sometimes a trade may be left out on its own even if you aren’t letting it run away. This can happen when you keep opening trades and they keep failing to close, whether it is because there isn’t a lot of activity or because you’re getting multiple trading signals or tips at once.
This comes under cash management: you should never keep trades open for significant amounts of time or keep large amounts of trade open because it heightens the risk of losing track of the trade. Some traders have daily trade strategies, others have weekly strategies, and some trade by the minute.
Obeying your own personal timeline will reduce your risk.
Key takeaway: Don’t keep large volumes of trades open for long periods of time outside of your strategy.
Risk #8: Listening to Too Many Advisors
It’s very easy to try to get information from anyone and everyone as a beginner, but everyone has their own trading strategy and what works for one person may not work for another.
Rather than soliciting tips and advice from anyone, traders should try to focus on a few sources of information or a single forex signal provider. This will vastly reduce the risk of following or chasing a tip that doesn’t fit in with your trading style. You also need to avoid tips and signals provided by inexperienced traders.
Key takeaway: Follow the advice of a few trustworthy sources rather than everything you hear.
Forex risk management is absolutely crucial for those who want to become serious traders. The forex market moves very quickly; without proper risk management you can make thousands overnight and then lose that and much more.
But by managing your risk you will be able to both capture profit and retain it.
Nearly anyone can make money on the market short-term; far fewer can make money over a longer-term though. Educating yourself on the potential risks and forex risk management techniques is the first step towards becoming a competent and consistent trader.
Try reading our article on finding a forex trading strategy.