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 an well-known fact that you have to risk more to earn more.
This is where the question of perfect risk management comes. In the following blog, we will elaborate on Forex trading risk management and How to manage Forex risk when trading. We hope after reading the article you will be able to understand risk management and make a strategy of your own.
What is Forex Risk?
Foreign exchange market is one of the biggest financial market on earth. More than 1.4 trillion US Dollars' transaction is made on Forex everyday. Therefore banks, financial institutions and individual traders have the potential to make huge profit or losses in here. In one word Forex risk is simply the profit or loss which is a result of the change in exchange rates. To minimize the possible financial loss, every investor needs to take some precautions and follow risk management strategy.
A big amount of people are trading on Forex market regularly. However, most of them are not being able to gain the expected profit. Even there are some who lost their all in trading. As a matter of fact, very few people are able to gain their expected profit or surpass the target. Forex market is very inconsistent, thus it bring great risks that everyone has to face. That's why Forex trading risk management is an popular subject in the traders' community.
Mistakes made by traders in Forex Risk Management
The main rule you should always remember when taking risk that you should never risk more than you can afford to lose. This is very common mistake made by beginners. Forex market is highly unpredictable. So, it is never wise to risk more than you can afford.
Forex market is easily effected by anything, the tiniest news can affect a specific currency's rate. It can affect in both positive or negative ways. You may also make profit of such news. It is very hard to control the greed or thirst to gain more, so we suggest you to get a hold of yourself and act wisely. It is highly suggested to follow a more moderate way than to go all in.
Emotional control in maintaining Risk Management Strategy
Being a able to control your emotions is a must have quality. The key to become successful in you trading career is going slow but steady. You will face loss when trading, in these situations you should not let your emotion control you. It is imperative that you control your emotions 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 if you have a long term strategy and you are trading against the market that is totally different.
You should be patient, but waiting too long in a position is not recommended. If you are stubborn and waiting too long in a position, you pose the 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 varies form 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 to follow the more opportune trades.
Always emphasize more on your mistakes, learn from them. Times you spend and efforts you make are the greatest investments. The knowledge you gather from your studies and mistakes are the ones who gains profit not your invested capital.
You should always remember these few things when trading. They will help you to reduce your trading risks -
- Value of money along with the currency exchange rates change 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 be able to identify the market trends and changes occurs in different sessions.
Forex trading tips: Risk Management
Some simple but important tips for Forex trading risk management is listed below:
- 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.
- 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 youself in other ways.
- Market Trend is your friend
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 long term alter your strategies on demand of the market trend.
After you started trading you will face different new crisis. You have to learn to keep your head cool and face these situations. Don't lose your cool if you make loss. Keep calm and learn from your mistakes.
- Limit the use of leverage
Using leverage is very tempting, you can make huge profits by using leverage. But, remember you can also easily lose large capitals. One tiny change in the market can nullify your total balance. Managing trading risk is not so hard, what hard is maintaining self-discipline and following the rules.
- Correlation in Forex Trading
Some currency pairs tend to go up/down together. Their changes are reflected on each other, this is called Correlation between currency pairs. The changes in one currency pair is reflected upon the changes of the correlated currency pair. The relation between "EUR/USD" and "AUD/JPY" is a good example of correlation.
So, now the question arises that "How does knowing correlation helps to reduce trading risk?" You should know by now that risk is driven by margin. You should not trade in pairs which have 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 time frame before choosing correlated currency pairs.
You will be able to handle your risks better if you understand the currency correlation. It is very helpful for Forex scalping. You can maximize your profit in a short period of time.
To become a successful Forex trader, it is mandatory to be able to manage your risk and minimize it. You should educate yourself regularly and remember the formula we discussed here.