Forex Risk Management

This aspect is one of the most important aspects you will ever read about trading.

Why is it important? In reality, we are in the business of making money, and to be able to do so we need to learn how to manage it well in order to prevent continuous loss. Ironically, this is one of the most overlooked areas in trading. Many traders are just anxious to get right into trading with no regards to their total account size. They simply determine how much they can lose in a single trade and get into the trade.

Trading on Forex, the investor has opportunities to multiply his money, but he also risks losing future profit and much more, the invested capital. Deviation from expected profit average is what determines the investor's risk on the financial market. Risk management methods are applied before and after opening positions. The main risk management method is applied to reduce losses.

Using Protective Stop-Loss to Control Risk

It is advisable to place a protective stop-loss for every open position. Stop-loss is a point when the trader leaves the market in order to avoid an unfavourable situation. When opening a position it is recommended to use stop-loss to insure against extra losses.

While in active trade it is good to protect your fund against potential total loss. That is the central purpose of money and risk management. Too often, the beginning trader will be overly concerned about incurring losing trades. Trader therefore lets losses mount, with the hope that the market will turn around and the loss will turn into a gain.

Almost all successful trading strategies include a disciplined procedure for cutting losses. When a trader is down on a position, many emotions often come into play, making it difficult to cut losses at the right level. The best practice is to decide where losses will be cut before a trade is even initiated. This will assure the trader of the maximum amount he or she can expect to lose on the trade.

Risk a Tolerable Account Portion Per Trade Position

To manage your invested fund well, you have to decide before the opening of any position how much of the money you can afford to lose in case the trade goes negative from your projection. For instance, you may decide that for every opened position your risked money will be 3%, 5% or 10% of the total fund, by so doing you have known prior to the execution of the trade the highest amount that can ever go out of your money on that single trading position, by so doing you have even taken away emotion.

The factor needed to work out this are:

  1. The fund balance in your account.
  2. The number of pip set as stop loss.
  3. The lot size (volume) traded.

For example:

Let's say your fund balance is $5000 and your predetermined stop loss pip is 50 pips (selecting the number of your stop-loss pips should be from your analytical research) and you are ready to risk only 2% of your fund for a position.
What do you do?
Work out the 2% of $5000
Which is = $100.
Implying that you can afford to lose $100 in case of any eventuality.
Then, Divide $100 by 50 pips
It will be $2
Your lot size must be 1 pip to $2. That will be 0.2 lot size.
So you must use 0.2 lot size.

As much as possible try not to be greedy, to be less greedy is to be able to minimize risk.

In a way leverage can help to control risk: if your leverage is relatively low it will limit you against opening a trade with high lot size.

Re-Evaluate Your Strategies

The other key element of risk control is overall account risk. If trade is going against you, at what point will you stop and re-evaluate your trading strategy? Is it when you lost 30% of your money or 50% or 80% or when you lost the entire money? Assess your market analytical methods and see if there would be need for further perfection or even a change.

Also, check out if your set lot size is too large for your entire account size.

Risk management and fund management go hand in hand. If you manage your funds well, you are equally reducing your risk. Also, if you control your risk well, you are equally protecting your funds.

by Duro Olorunniji