Risk management is one of the most important concepts for a Forex trader. It is an easy notion for traders to grasp, but quite difficult to actually apply. Forex brokers often hint at the various ways available to manage your risk but they spend much time focusing on how to be profitable and not enough time on how to avoid the losses involved in the first place.
The first step in risk management is to calculate the odds of your trade being successful. To do that, you need to grasp both fundamental and technical analysis. You will need to understand the dynamics of the market in which you are trading, and also know where the likely psychological price trigger points are. Price charts can be a big help when trying to reach this decision.
Once a choice has been made to follow through on the trade, the next step to consider is what moves to take in order to control or manage the risk involved in the trade. Keep in mind that if the risk is measureable, you should be able to manage it.
One of the most important forms of risk management is controlling your losses. You must ask yourself at what point will you know that it is time to cut your losses on a trade. To do this, you can choose between a hard stop and a mental stop. A hard stop is when you set your stop loss at a certain level before initiating your trade. This can be done by selecting any relevant trading tool available, such as a stop loss order.
A mental stop is when you set a limit to how much pressure or stress you will take for the trade. Figuring out where to set your stop loss, either mentally or physically, is a science on its own, but the main thing is it has to be in a way that reasonably limits your risk on a trade and fits in with your trading psychology. Once your stop loss is set in your head or on your trading platform, make sure to stay with it. It is easy to succumb to the trap of moving your stop loss farther and farther out. By doing this, you are not cutting your losses effectively and you will run into trouble in the end.
All traders, newbies or experienced, know that they must take responsibility for their own decisions. In Forex trading, losses are part of the norm so it is up to the trader to learn to accept losses as part of the investment process. Losses should not be considered failures; they are an integral result of any trading undertaking. However, if a trader does not take a loss at the right time, it is a sign that he/she is failing to conduct proper risk management. Too often, when a trader’s position moves into a loss, he will second guess his system and wait for the loss to turn around and for the position to become profitable. This is fine for those occasions when the market does turn around, but it can be a disaster when the loss gets worse. This is exactly a case of reaching your mental stop and not following it through as planned.
Risk management in Forex trading takes a good deal of mental conviction and fortitude but it is worth the effort.
About the author: Dan Gedim is a Forex and Binary option and has been trading the Forex market for over 8 years. He is also a freelance writer who loves to share his thoughts about the Forex market and investing in general. He currently lives in Richmond , London. You can find more of his work at FXAcademy.com