The most debated topic in Forex trading is “Risk Management.” All traders want to reduce the amount of potential loss; at the same time, they want to make the maximum profit possible from a trade. It is a well-known fact that you have to risk more to earn more.
This is where the question of perfect risk management comes in.
In the following blog, we will elaborate on Forex trading risk management and How to manage Forex risk when trading.
After reading the article, we hope you will be able to understand risk management and make a strategy of your own.
Why is Forex Risky?
The foreign exchange market is one of the biggest financial markets on earth. More than 1.4 trillion US Dollar transaction is made on Forex every day. Therefore banks, financial institutions, and individual traders can make huge profits or losses here.
In one-word Forex, the risk is simply the profit or loss resulting from the change in exchange rates. To minimize the possible financial loss, every investor needs to take some precautions and follow a strong risk management strategy.
A large number of people are trading on the Forex market regularly. However, most of them are not being able to gain the expected profit. Even some lost their all in trading. Very few people can earn their expected profit or surpass the target.
The Forex market is very inconsistent; thus, it brings excellent risks that everyone has to face. That’s why Forex trading risk management is a popular subject in the traders’ community.
Traders’ Mistakes in Forex Risk Management
The main rule you should always remember when taking a risk is that you should never risk more than you can afford to lose.
This is a widespread mistake made by beginners. The forex market is highly unpredictable.
So, it is never wise to risk more than you can afford.
Forex market is easily affected by anything; the tiniest news can affect a specific currency’s rate.
It can act in both positive and negative ways. You may also make a profit from such notice. It is tough to control the greed or thirst to gain more, so we suggest you get a hold of yourself and act wisely.
It is highly recommended to follow a more sensible way than to go all in.
Emotional Control in Maintaining Risk Management Strategy
Being able to control your emotions is a must have quality. The key to becoming successful in your trading career is going slow but steady.
You will face loss when trading; you should not let your emotions control you in these situations. You must maintain your feelings and cool your head; otherwise, you will fail to achieve your goal. You should have the mentality to go with the market’s flow.
If you be stubborn and try to go against the market, you can not go very far. Though you have a long-term strategy and are trading against the market, that is different.
You should be patient, but waiting too long in a position is not recommended. If you are stubborn and wait too long in a position, you pose a risk to lose your capital to yourself.
After realizing your mistake, you should exit the market instantly. Then be patient to re-enter the market.
Strategic Trial & Error: Get Better at Managing Risk
There are many trading methods to avoid risk management mistakes. You should test them and find the most suitable one for you. The best method won’t always work for you. You should choose the one which fulfills your desire and works best for you.
Strategies vary from person to person.
Whichever method you prepare for you, it should be practical and you should be able to follow it properly. Forex experts advise following the more opportune trades.
Always emphasize more on your trading mistakes more, and learn from them. The times you spend and the efforts you make are the greatest investments.
The knowledge you gather from your studies and mistakes are the ones who gain profit, not your invested capital.
You should always remember these few things when trading. They will help you to reduce your trading risks-
- The value of money, along with the currency exchange rates, changes continuously.
- Assets, liabilities ad money streams are influenced by changes in global exchange rates.
- You should trade in small amounts at the beginning and observe the market. If you do so, you will identify the market trends and changes that occur in different sessions.
Trading Tips: Forex Risk Management Strategies
Some simple but essential tips for Forex trading risk management are listed below:
1. Stop Losses:
You should always set your stop-loss. You should use stop-loss as your safety point. And to do that, you have to define how much loss you can bear.
2. Don’t invest all your capital in one place:
This tip applies to all types of investment. Forex should not be the only source of your income. You should always expand yourself in other ways.
You should know that Forex can not be manipulated. You should always follow the market trend. You should not fight the market. If you are not planning for the long term, alter your demand for the market trend.
After you started trading, you will face a different new crisis. You have to learn to keep your head cool and face these situations. Don’t lose your cool if you make a loss. Keep calm and learn from your mistakes.
4. Limit the use of leverage:
Using leverage is very tempting; you can make huge profits by using leverage. But, remember, you can also quickly lose large capitals. One tiny change in the market can nullify your total balance. Managing trading risk is not so hard; what is hard is maintaining self-discipline and following the rules.
5. Correlation in Forex Trading:
Some currency pairs tend to go up/down together. Their changes are reflected in each other; this is called the correlation between currency pairs. The changes in one currency pair are reflected in the changes in the correlated currency pair.
The relation between “EUR/USD” and “AUD/JPY” is an excellent example of Correlation.
So, now the question arises “How does knowing correlation help to reduce trading risk?”. You should know by now that a margin drives risk. You should not trade in pairs with strong correlations because you will be wasting your margin if you trade in correlated pairs.
After all, they are likely to result in the same point. However, Correlation differs in different time frames. You should consider the time frame before choosing correlated currency pairs.
You will be able to handle your risks better if you understand the currency correlation. It is beneficial for Forex scalping. You can maximize your profit in a short time. To be a successful Forex trader, it is mandatory to manage your risk and minimize it.
You should educate yourself regularly and remember the formula we discussed here.