If you want to become successful trading forex, you must learn about the risks involved. Forex risk management is what separates winners from losers in this industry. Risk management are the strategies that traders use to avoid potential loses. These techniques may involve trading only during certain days or hours, hedging, understanding the right time to accept losses, or reducing your trade lot size.
The Importance of Forex Risk Management
Any trader that wants to be successful trading forex must understand how risk management works. It’s a simple concept to learn, but extremely hard to apply. Forex brokers like to discuss about the reasons why using leverage is a great idea without focusing on its disadvantages. In this light, many traders are usually misled about taking large risks expecting huge returns. Of course, this concept might work when using a demo account, but things are different when trading with real money. This is when you will realize the importance of risk management.
- Controlling Losses
Risk management helps in controlling losses. As a trader, it’s wise to know when to accept losses. There are two options to choose from, a mental stop and a hard stop. A mental stop is whereby you define how far you are willing to go when trading. A hard stop is whereby you define a loss (stop loss) that you are willing to incur when you start trading.
Knowing where to define your stop loss is an act that is not easy to master. However, the limit that you set should help you to reduce the risk on your trade and be reasonable. Once you come up with a stop loss that you believe will work for you, you are advised to stick with it. Do not be fooled into changing your stop loss. If you become a victim of this temptation, your trading might be affected significantly.
- Using the Right Lot Sizes
Don’t be fooled by the tricks that forex brokers use just to sign you up. Some brokers have a habit of playing with numbers or saying what many people want to hear. For example, it’s not possible to open an account today, start trading and wake up rich tomorrow. There’s no exact formula that can be used to calculate the right lot size for you. However, traders are advised to trade small in the beginning.
The amount of risk that traders are willing to take varies from one trader to another. The best way to go about this is to start small, and increase your lot size gradually. There are advantages and disadvantages of using a larger lot and smaller lot. However, it’s easy to manage an account that uses smaller lots compared to the one that uses larger lots.
We all want big returns, but very few of us are willing to risk huge amounts. Some people are willing to take up to $10,000 just to open a forex account. However, before you decide to invest such a big amount, it’s important to understand the risks that you are expected to experience.
- Tracking Overall Exposure
It’s always wise to use smaller lot size when trading forex, but they may not be very useful if you open many of them. Also, as a trader, you should try to understand the relationships between different types of currencies. For instance, let’s say that you go long on USD versus CHF and short on Euros versus the American dollar, it means that you are exposed in the same direction twice with the USD. This is equivalent to two long lots of the American dollar.
In the event that the value of the American dollar drops, you are going to incur two losses. In this regard, if you want to succeed in forex trading, it’s in your best interest to reduce your exposure. That way, you will limit your risk and remain relevant for long.
Forex risk management includes everything that you are willing to do to manage your losses. If you learn how to reduce your risk and control your losses, there’s nothing that can stop you from becoming a top earner trading forex. It’s all about opportunities and knowing when to take advantages of these opportunities when they arise. As a trader, you are always advised to be ready to use all the opportunities that you get wisely.