As we all know, trading forex can be risky. Traders in a constant search for a great trading opportunity – they seek making a profit. This is great, but not everybody is paying enough attention to another dimension of making an overall profiting: limiting the risk.
How can we limit the risk? Here are 3 basic methods.
- Risk reward ratio: The first thing is profit related. The potential profit should be double or more than the risk. 3:1 is even better. This doesn’t mean limiting the stop loss or extending the take profit targets in order to achieve the desired risk reward ratio – it’s a critical measure if the trade has potential or not. If your system produces a trade that has a plausible risk reward ratio, it’s a good trade. Otherwise, it isn’t. A high risk reward ratio means that you can have more losing trades than winning ones, but still be successful in making profits on the long run.
- Limiting a single trade’s loss according to the account size: Basic money management means that you are aware of the percentage of loss to your total account on every single trade. A maximum loss of 2% of your account is optimal. Also 3% can be considered sound.
- Smaller trades in times of high volatility: You cannot anticipate breaking news, but there are quite a few known events which result in high volatility. Non-Farm Payrolls and rate decisions are scheduled and usually rock the markets. If you plan to trade before or after these events, more caution is needed. You can tighten your stops, stay more connected to the markets and most importantly reduce the size of the position than on calmer times.
How do you limit your risk? Are you using any of these methods? Do you reduce position sizes or tighten stops in times of high volatility?
Further reading: 5 Most Predictable Currency Pairs – Q3 2012Get the 5 most predictable currency pairs