Risk Management in Forex

As any accurate brochure or legitimate broker will inform you, Forex is a risky business. You are taking a risk with every trade you place; it is a calculated risk, and since nothing in life is certain, this is not an unreasonable way to make a living. You have probably heard people say that investors are gamblers. Many are — but a few are not, and it is the few who are not who succeed. The difference between a gambler and a real investor comes down to risk management.

There are three main components of risk management in Forex: money management, a trading method, and psychology. There is no trading method which is invulnerable to the changes in the market, and no trading system which is foolproof. At the same time though, it is extremely important that you have some kind of a method, and that you test that method and prove its efficacy before you trade real money. This keeps your trades from being random — up to a point. Your system is not all you need to test. You also need to test yourself.

How do you handle risk in Forex? There is no one single best approach to dealing with risk in Forex or any other pursuit, since everyone is different. Most people will err on the side of either caution or recklessness. Before you trade with real money in Forex, it is essential for you to figure out which you tend toward — caution or recklessness. It is fairly obvious why reckless trading can blow your account; overly cautious trading can be just as destructive, though. Erring on the side of caution may lead you to exit (or simply not take) all the best trades before they become profitable — while still suffering substantial losses.

Whether you tend to trade too often and exit too late, or trade too seldom and exit too early, the failure is in not trusting your methodology. If this is because you have not done enough testing, then it is back to demo until you feel more confident. If you have tested your trading method and you have excellent results, then you will need to examine why you are not confident. It may have nothing at all to do with the Forex system you have developed — you may exhibit the same patterns in other parts of your life. If so, you will need to learn to adjust for those behavioral patterns in your Forex trading.

Finally, managing risk involves managing money. You should never trade more than a tiny percentage of your account at any point in time. Most successful Forex traders only trade 2.5% of their accounts on any given trade. If you do add on when a trade goes in your favor, you will need to create a systematic way of doing so with discipline.

You have probably read or heard that you need to learn to trade Forex without emotion. While you can control your emotions to some degree, the reality is that all of us are going to feel some emotional response to risk now and again while trading Forex. The key is to learn how best to integrate those emotions into your trading or remove your trading from your emotions — depending on the person. The only way you can do that is to study yourself, not just the market.