Managing risk in forex trading
All money-making ventures involve some level of risk, and forex trading is no different. The smart investor knows that in order to be successful, besides a good knowledge of the industry and its trading platforms, a robust risk-management system is needed to safeguard capital from unexpected losses.
Although entirely eliminating losses from trading is impossible, knowing how to manage risks can help to check losses and make investments profitable in the long term. In what follows, we will look at five ways you can manage risks when trading forex, so as to limit losses and increase overall profits.
When you enter a trading position, you naturally expect the market to move in your favour – that’s why you made the trade after all. But the market can be unpredictable at times, especially during periods of high volatility, and can take a sudden swing against your position, leaving you with a deep hole in your account. Placing a stop-loss order along with your trade can prevent this from happening and protect your capital. As the name suggests, a stop-loss order will stop the losses incurred from a trade that has unexpectedly turned against you by automatically ending the trade at a predetermined price. Having a predetermined exit price also prevents traders from holding onto bad trades in the hopes that they will turn good. Trading should be based on logical decisions based on market research, not hopes or fears, and deciding on a stop-loss limit before entering a position saves you from having to make emotionally-charged decisions that can cost you dearly.
A trader’s mind can be muddled not only by hopes and fears as he watches a trade move against him, but also by greed when a trade moves in his favor. It’s natural to want to make as much profit as possible from a winning position, but one must know when to close a trade and take his profits. When you think that the price of a pair, for example, will reach a certain level, but are unsure how it will move beyond that level, you can set a take-profit order, to automatically close your trade while it’s winning and take your profits before the price moves against you. Knowing when to close winning trades and take profits is the best way to move ahead in your trading.
A great advantage of forex trading comes in the leverages offered by brokers. Leverage, which can sometimes be as high as 1000:1, allows traders to make big profits from small market movements by multiplying the value of their trades. By the same token, however, when a leveraged trade turns against the trader, he can lose a great deal of money. In order to manage risks and minimize losses, a trader should limit the amount of leverage taken on each trade, especially during periods of high volatility, since even the slightest unfavourable movement in a leveraged trade can wreak havoc on your account.
The ‘two per cent rule’
It may seem tempting when trading to risk the entire amount in your account on a single trade, in the expectation that the market will go exactly as you think. As we’ve already established however, the market can often move in unexpected ways and smart traders never trade on hopes and expectations, but on logic and predetermined strategy. The best policy when it comes to determining how much to risk on a specific trade is to follow the ‘Two Percent Rule’. By limiting each trade to two percent of your available trading capital, you give yourself more chances for placing winning trades and limit the amount of money you can lose on a bad trade.
Know your underlying assets
Currency trading is based on the premise of one currency competing against another, so it is imperative to know your underlying assets inside out and manage your market risk. When trading the EURUSD, for example, make sure you know what’s going on in the market, and stay informed about the daily economic events in the Eurozone and the United States. Economic events have an impact on currency values and can trigger volatility, so your risk management strategy is benefited by being in the know about market events.
Although trading positions can be opened and closed quickly, trading forex should be approached with a long-term strategy in mind. The anticipation of big wins may appear attractive at first, but big trades can also leave you with deep losses that are hard to recover from. Successful traders know how to manage risks by cutting their losses and taking profits at the appropriate times, and always sticking to sensible trading amounts and leverages, patiently building up their trading accounts little by little.
Akinyele works with ForexTime Nigeria
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