Guide to Risk Management

Getting into the Forex market can be a thrill in its own right but you have to be aware of the risks that come with getting into this field. In particular, you have to watch for what you can do to keep risks from being worse than they could be.

You don’t want to end up risking more money on the market than what you can afford, right? The last thing you want to do is get out of the Forex market with nothing on hand after a short period of time.

Remember, investing in the Forex market can be unpredictable. It’s like a form of gambling except it’s one that is legal everywhere and doesn’t really have much of a questionable slant to it (not to mention it’s not potentially fixed or anything).

What is risk management?

Risk management involves finding a way to keep risks under control. This is to ensure that you know what you are risking and that you are not trying to spend more money than what you can afford to handle. It’s about seeing that you are only spending a certain total based on what you are comfortable with.

Capital requirements

Trading capital is a good measurement to review just as well. Trading capital entails the amount of money you will be using for trading purposes. This can be reviewed based on the investments that you want to get into, the amount that you plan on investing and any commissions that you will have to spend.

You must see how your capital will be used in a trade as the capital can easily decline in value or go up depending on how a trade works. You must especially be cautious when seeing how a trade is organized as you need to have only trading capital that you know you can actually afford to lose.

Drawdowns

Drawdowns occur when there is a reduction in your total trading capital after losing money on some trades. This is typically measured as a percentage of your account.

The peak and trough are two points that may be used in your drawdown to see what is happening with your investment. The peak is the highest total of the drawdown and the trough is the lowest. You should use these to identify how your investments are going and if there are points that might cause your investment to decline in value.

How much to risk?

It is best to go after a maximum risk of 5% of your portfolio on a single trade. You need to keep your portfolio intact to where a single losing trade will not cause you to lose a great deal of money.

A greater loss of capital will mean that you have to put in more of an effort to get back what you lost. This is all just to help you break even. You have to limit your total risk so you will not fall too far back in your investment.

Reward-to-risk ratio

The reward-to-risk ratio is the potential for you to make a certain amount of money times the money you risked.

The ratio works with a simple readout:

The potential for you to make money : What you risk

You can calculate this by looking at the trends on a pair to see how the value can go up while it can also go down. You can use this information to help you understand what the best deals to get into might be.

You can always get a good trade if you have a smart reward-to-risk ratio to make it work. A 3:1 ratio is always a good total to look for. This will show that you can make a greater amount of money off of your investment if you do your research and find a proper investment.

Check on the trends and lines within an investment to see what you can get out of a pair so you’ll have a choice that you know is easy to follow through with. Be careful when calculating the ratio as anything below a 3:1 ratio may not be a good option for you to invest in.

Additional tips

There are a few extra tips that you can use for your risk management needs:

  • Look at the high and low bands on a pair versus the current price of an investment. This is to give you a better idea of the total risk that you will get into. This can help you understand what you might possibly lose while helping you compare it with the profits you might earn.
  • Always look at the market sentiment on certain pairs so it will be easier for you to trade something the right way.
  • Take a look at what might drive a currency pair before you choose to invest in it. Always see if there’s an underlying story or news report that might lie underneath anything you are investing in.

Keeping a journal

The idea of keeping a journal, on the surface, sounds quaint and old-fashioned but it can actually make a difference when getting an investment ready. You can always use a journal to record information on how well your trades are going and what you can do to make them more effective and potentially profitable. This can work well as the logs that a broker or account provider might hold may not give you enough information on how your trades have been working.

You need this journal to keep track of what you are getting out of your investment. You must keep this to not only help you learn from what you have done but to ensure that you trade less with your heart and more with your mind.

In particular, a journal can help you keep track of the following:

  • The areas you are trading in
  • The entry positions you take; this includes the triggers that you take in order to get ahead
  • The position size to use
  • What areas you feel you are the most confident in
  • How your trades have done based on what you did to get in there and how you felt as the trades were moving along
  • Your reactions to your outcomes; you must have reactions regardless of how good or bad the outcome was

Journal features

You must make sure you have plenty of useful things in your journal. Your trading journal can include the following features:

  • List your motivations and interests in trading within your journal. This can help you with figuring out the proper strategy you want to use.
  • Think about your market views and how you see it. Let this information flow throughout your journal so you’ll have plenty of information to work with.
  • Write down your own personal feelings about the market and see if you have any particular ideas for how you want to invest at this point.
  • Write about any missed opportunities or errors you might have made while trading. You can write about what you feel you have done wrong and then discuss what you want to do over time through your own personal monologue.
  • Keep tabs on any statistics relating to what you are doing while making trades.

Understanding the risks involved in FX trading is vital, but managing those risks are even more important. Keeping a journal can always help you in this task, as writing things down always presumes a higher understanding of the process. From another side, getting a certain Forex bonus can be a good idea as it provides an additional margin, so you can generate higher returns while risking the same amount.