With a global trading market of over $1.93QD and trillions of greenbacks circulating daily, it’s safe to say that the Forex market is one of the best-liked trading options – and it’s bound to remain so. It’s a market that, if you watch closely, you can begin to see changes in economic policies coming and, as a result, currency values. Because of this understanding, many beginners are attracted to Forex trading and are eager to invest some money to gain valuable experience. But that’s not all; let’s remember that trading is, in the end, about yielding returns. The moment that the trader observes profits flowing into their account and realizes the possibility of earning even more, they’re already engaged in forex trading.
Whether you’re a curious newcomer or a seasoned investor, the thought of risking your investments’ value has probably given you the chills. The fact that one can continuously improve their risk management strategy is a reality to acknowledge. Developing and using a reliable risk management strategy can be the decisive factor between striking it rich and blowing up your investment, so if you’re committed to your discipline, you have fewer reasons to steer away from forex trading. Provided you don’t invest more than you can afford to lose or partner up with sketchy forex trading platforms, you should have a smooth experience and build up your knowledge as you go. To maximize your trading success, stick to a solid risk management strategy — and explore our guide to crafting your own effective approach.
First, what’s your risk tolerance?
Sometimes, the line between overstating and understating one’s risk tolerance can be dangerously fine – as is the line between jumping on a risky stunt or overlooking a golden opportunity in trading. If you’ve ever come across a hot recommendation in trading, it’s likely to be the one that calls for a good understanding of the personal risk level. This limit boils down to your capacity and preparedness to tackle fluctuations in your investment’s value, as well as how comfortable you are with a currency’s volatility. The same applies to other trades, too. For instance, you might be trading crypto, in which case you need to determine the level of uncertainty you can deal with in the event of money loss.
Should you go with historically volatile pairs like the US Dollar/South African Rand, the British Pound/Australian Dollar, or the US Dollar/Turkish Lira, you might expose yourself to too much volatility. Massive volatility is good when you’ve appropriated some knowledge and expertise in the field. Contrastingly, if you only seek a haven for your money or want to exchange some of your local currency for a stable unit, you can consider investing in the strongest currency in the world and leave your money to lie dormant until you feel ready to explore trading pairs. Many brokers choose to exclude the strongest currency worldwide from the trading pairs offered, given that there’s little to no room for ranking changes in the foreseeable future.
Position sizing
There are three big lots in forex, namely standard, mini, and micro, and the position size represents essentially the number of lots taken on a trade. As you begin to test the waters, you’re advised to go with the mini and micro lots. Too small or too big position sizes might expose you to excessive or insufficient risk, none of which would benefit you as a newcomer.
Forex trading risk management boils down to regulations and rules that help you decide on the right trade or position for your transactions, depending substantially on your account size and experience. The exemplar position size, aligned with regulations, is estimated by dividing total risk capital by trade risk. Committing to the safe size helps protect your account from running insolvent, should you experience a market downturn.
Stop-loss orders
Regardless of other investors’ predictions or prevailing trends, the volatile currency market can take on any trajectory at any time given. Because market movements can’t be forecasted, it’s important to use the stop-loss order mechanism to safeguard your investment from potential losses during adverse movements. This is a solution provided by online brokers to help slash losses when the client’s position doesn’t align with the market moves and previous expectations. It’s easily implementable, requiring choosing an “exit level,” a pre-determined number of pips from your entry price.
There are more stop-loss orders to opt for, so let’s discuss the first and most popular one for newcomers. The static stop is the most beginner-friendly choice of stop-loss you can use for your trades, entailing establishing an exit price level that will draw you out during market downturns in order to limit losses. You don’t need to be present when this happens, which is good since the market waits for no one to connect and sell risky assets. Nevertheless, once the predetermined price level is hit, the stop converts into a market order. This means that your trade might not be executed at the exact price set but could be filled at the closest price available.
Risk-reward ratios (RRR)
The risk-reward ratio is one of the most prevalent risk management strategies, coming down to gauging the total profit possibly obtainable per each risk unit taken in a trade. It’s practically estimated by dividing the anticipated profit by the capital you’d be fine if you lost, supposing the trade does an about-face. As expected, the lower the ratio, the higher the risk and the less profit you can make. Contrastingly, the higher the risk-reward ratio you commit to, the higher the reward and the lower the risk.
You’ll have a few variables to use, among which are the entry price, risk, take profit, stop-loss, and lot size. The stop-loss, for instance, can be a game-changer as it determines the price point at which you want to drop a losing trade to slash potential losses. Overall, the RRR is an essential factor in settling on a trading strategy’s profitability, helping you find the right balance between risk and reward to make successful trades in the market in the long run.
Endnote
It’s not only practice that makes perfect, but a combination of discipline, determination, and common sense. The right risk management strategy will have you rest assured knowing you’ve done everything in your power to cap possible losses.
