Lesson 8: Understanding Forex Risk Management

Forex risk management can make the difference between your survival or sudden death with forex trading. You can have the best trading system in the world and still fail without proper risk management. Risk management is a combination of multiple ideas to control your trading risk. It can be limiting your trade lot size, hedging, trading only during certain hours or days, or knowing when to take losses.

Why is Forex Risk Management Important?

Risk management is one of the most key concepts to surviving as a forex trader. It is an easy concept to grasp for traders, but more difficult to apply. Brokers in the industry like to talk about the benefits of using leverage and keep the focus off of the drawbacks. It causes traders to come to the trading platform with the mindset that they should be taking a large risk and aim for the big bucks. It seems all too easy for those that have done it with a demo account, but once real money and emotions come in, things change. It is where true risk management is important.

Controlling Losses

One form of risk management is controlling your losses. Know when to cut your losses on a trade. You can use a hard stop or a mental stop. A hard stop is when you set your stop loss at a certain level as you initiate your trade. A mental stop is when you set a limit to how much pressure or drawdown you will take for the trade.

Figuring out where to set your stop loss is a science all to itself, but the main thing is, it has to be in a way that reasonably limits your risk on a trade and makes good sense to you. Once your stop loss is set in your head, or on your trading platform, stick with it. It is easy to fall into the trap of moving your stop loss farther and farther out.

If you do this, you are not cutting your losses effectively, and it will ruin you in the end.

Risk per Trade
Another aspect of risk is determined by how much trading capital you have available. Risk per trade should always be a small percentage of your total capital. A good starting percentage could be 2% of your available trading capital. So, for example, if you have $5000 in your account, the maximum loss allowable should be no more than 2%. With these parameters, your maximum loss would be $100 per trade. A 2% loss per trade would mean you can be wrong 50 times in a row before you wipe out your account. This is an unlikely scenario if you have a proper system for stacking the odds in your favor.

Using Correct Lot Sizes

Broker's advertising would have you think that it's feasible to open an account with $300 and use 200:1 leverage to open mini lot trades(0.1 lot) of 10,000 dollars and double your money in one trade. Nothing could be further from the truth. There is no magic formula that will be exact when it comes to figuring out your lot size, but in the beginning, smaller is better. Each trader will have their own tolerance level for risk. The best rule of thumb is to be as conservative as you can. Not everyone has $5,000 to open an account with, but it is important to understand the risk of using larger lots with a small account balance. Keeping a smaller lot size will allow you to stay flexible and manage your trades with logic rather than emotions.

The risk is inherent in every trade you take, but as long as you can measure risk you can manage it. Just don't overlook the fact that risk can be magnified by using too much leverage in respect to your trading capital as well as being magnified by a lack of liquidity in the market. With a disciplined approach and good trading habits, taking on some risk is the only way to generate good rewards.

This is ending in Lesson 8, add a comment if you have any question related to this. I hope you will get this better chance by registering under me. So, see you with Lesson 9.

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