What is Forex risk management and why is it necessary? Can it really help to manage the negative impact of false trading? What are the tools necessary to implement some effective forex trading risk management strategies? You will find questions about these and other answers in this article.
Trading cannot be successful without a proper plan. Of course, Forex is not only about planning. However, you should work out your tactics in advance considering all possible outcomes including the bad ones. This is where technical analysis, indicators, and trading charts help in some way or another. But they are not enough to manage all the risks traders are taking every day when entering the market.
Major forex trading risks to manage
Before we learn how to manage risks, we need to know our enemy. So, the main trading risk types are as follows:
- Currency Risks – this type of risk mainly refers to the currency price fluctuation. In other words, at some point trading, a currency pair may be less or more expensive.
- Interest Rate Risk – no one can predict the rise of the interest rate. It can make unexpected moves that affect volatility greatly. As a result, the traded or investment volume will change as well depending on the change direction.
- Liquidity Risk – this type of risk is associated with the inability of traders to purchase or sell the asset as quickly as possible to gain maximum profit or prevent huge losses. The situation may result from different geopolitical, economic, and other events that have an impact on market liquidity.
- Leverage Risk – it occurs when a trader forgets about how much he or she has invested or put at risk.
Now when we know our enemies, we need to work out a versatile strategy to ensure an effective Forex trading risk management.
#1 - Figure out how the market works
To act successfully on the market, you need to understand how it works. What type of instrument are you going to trade? What is your trading strategy? Do you prefer going short or long-term investments? What tools and indicators are you going to use?
Decide on where you will trade - an online platform, a spot market, so on. It all starts with the Forex basics and education. You need to learn fundamental things about the financial market. It will let your work out more effective risk management strategies in forex trading.
#2 – Consider the leverage
Forex is mainly about speculating. You need to take a grasp on the price movement along with the CFDs or spread bets. In other words, you should be prepared to trade on leverage, as the best option to benefit from the market exposure even from a small initial deposit. Magnified losses are the major downside here. It is always good to have several forex trading risk management strategies depending on the style you use on the financial market.
#3 – Build a plan
The next stage is to develop a reliable forex risk management plan. It should be based not only on news and analytics you generate but also on your personal experience. It ensures better decision-making with a more versatile market overview.
Some beginners usually opt for well-known strategies used by traders that are more successful. It might be a not as good idea as it seems unless we are talking of copy trading. If not, you should work out a strategy that applies to you personally. A good idea is to have a trading diary with about successful and lost trades written down. It helps to analyze your actions and make prompt adjustments to manage forex trading risks.
#4 – Start with a demo account
A demo account is a great chance to pick up skills or test the strategy under real market conditions. It is a risk-free mode where you are not required to make real deposits. On the other hand, you get full access to the trading platform with all the functionality and features.
The best point to start is to open a free demo account with $5000 on demo-balance, copying 100% real market conditions on a real trading platform MT4. Here you can learn how to trade without risking your money, and then proceed on the same platform in live, when ready.
#5 – Risk-reward ratio
The only way to outweigh your losses is to set a proper risk-reward ratio. It does not matter if you lose a couple of hundreds of short individual trades. Everybody loses. The question is how much you will make in the long run. Besides, the risk-reward ratio makes it possible to quantify the trade's worth.
#6 – Stop losses and order limits
With so many different tools and forex trading risk management strategies, preventing losses is not as challenging as it sounds. All you need is to consider buy and sell order limits as an important tool that prevents unexpected losses.
What's more, traders can benefit from various types of stop-loss strategies. They include trailing and normal stop losses. However, they do not provide 100% protection from slippage taking into account the Forex market liquidity.
#7 – Keep control over emotions
Managing emotions is vital for any trader despite the background or experience. Discipline can be the dominating force when having your back against the wall. Whatever happens, you need to stick to the plan or trading strategy you have worked out earlier.
To feel more confident, make the most of news, events, and analytics. Make sure you use a versatile approach with different trading indicators and instruments.
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.