Risk management is the kind of thing that you probably associate with your grandparents. Bland, unexciting, punching in at the same job for thirty years…. and probably smoked cigarettes because the doctor said it was “healthful”! They saved and maybe if they were risk takers, bought bonds.
But for the Forex trader, risk management is not just for the risk averse. It is the single most important skill that a trader can have for the longevity of their trading.
Let’s discuss a few key thoughts and share a few tips.
Understanding the position size
This is a given. You simply cannot open a position without first understanding the value per pip of the position. For a new trader, this is the first skill to master, and while it can be tricky at first, with repetition, you will find yourself getting a handle on it quickly. It seems obvious, but with instruments having different leverages and your account having various levels of usable margin and used margin, it can get a bit complex even for experienced traders.
The impact of volatility
Market volatility can affect the safety of your positions. Knowing how the market behaves on a normal day will not prepare you for unusual volatility and a sharp swing against you in a position that had no protection can result in a margin call. The feeling of watching it swing back to profitability after the margin call has been known to bring a tear to the most hardened of trader’s eyes.
Keep an eye on slippage in particularly volatile markets. Anyone who trades on high volatility needs to ensure their broker’s system will hold up and execute properly.
Risk versus benefit
This should be the rock on which your trading is based. Before you begin your trading, you need to have determined a level of exposure you are willing to risk on each position (and the potential profit). Then place the take profit and stop loss on these points.
Regarding the benefit aspect, only make a trade if you are confident in its success. If you are not confident but hopeful, don’t make the trade. You want to trade on your wits, not your luck.
While it doesn’t work for every style of trading and trader, try to limit the size of your position to a small percentage of your account. We don’t have the 5/15 rule for Forex, but look around, and you will find some strong conservative recommendations from risk management experts (usually around 2% of your balance).
Control your losses (AKA put in a stop loss)
Not to put too fine a point on it – this is what prevents your account from going to zero when you are not looking, so put in a stop loss whenever you trade. Make sure it is at a level that will allow it to engage in a margin call. Do this for every position. EVERY POSITION!
How to think
There are so many ways to manage your risk, but probably the single best asset is to think negative. How much can I lose? What is the relative risk? As a forex trader, you are naturally geared to think positively, regarding how much you can make. If you remind yourself of how much you can potentially lose, you will be more likely to protect yourself and your hard-earned money.
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