In my tenure as a coach and broker I have observed that 90% of the helpless and frustrated lot is a result of bad risk and money management strategies. Sometimes even complete lack of it. Can you imagine people getting into something as risky as Forex with a few trading bestseller guides, some seminars they’ve attended, and money?
But they do! The money is their reason for confidence; the fact is – knowledge should be. Risk management is nowhere to be seen. They have money and they are here to make money is their mindset. Had they considered safeguarding the money they are coming to the business with – their risk management would have been in place. But alas in most cases that is not to be. Losses are something you cannot avoid in trading but you have to learn to manage your losses wisely is the key.
Forex as we know is a high risk market. The reason is that the market fluctuations and movements are highly explosive in nature besides being erratic and unpredictable. It is very rare to come across a trader who books consistent profits trading Forex; and in spite of this, it is a very popular way of trading across the globe.
Especially post the advent of Internet it has become a lot more accessible to regular public. The fact that the market works round the clock for five days in a week and action is happening at a global level, plus the convenience of being able to trade it as per one’s own preference – from home, from office, full time, part time etc makes it an attractive proposition.
Plus the impression that goes with Forex is that you can ‘make a few thousand dollars overnight easily – if you can manage to get your trades right’ sounds so attractive to people that they can’t help taking their chances with it. Mostly they either do it on an impulse or they aren’t prepared for it; which is one aspect of the risk we associate with Forex. Therefore managing risk is a critical part of trading Forex.
The first lesson while one is planning the risk management strategies comprises one principal – be clear about the kind of money you can afford to lose while trading; be realistic and think of protecting your capital before you start imagining booking of profits.
For protecting your profits you should get into the habit of placing stop loss orders, which means when you place an order for a currency pair at a certain exchange rate; as you are expecting the market to move favourably which will help you earn profits of the trade; keeping your momentum intact, also be prepared for the losses, that may occur lest the market does not move as expected. For this placing of stop loss orders is recommended; placing a stop loss order at an exchange rate beyond which you would not like to lose money will limit your losses to a great extent.
Likewise another risk management strategy is not become too greedy when the times are good. When you place a trade and market does move in the direction as expected, place a limit order and book your profits and close the trade. In the hope of making a little more money do not hold on to your trade for a little longer; because market will suddenly take a U turn without giving a minute’s notice and you will end up losing everything before you know it.
It’s an everyday story in the Forex Market that greed kills otherwise good trades. However people do it all the time in spite of being consistently warned against it.
Another risk management strategy is to be clear about your position size. Leverage offered in Forex is sometimes almost 500 times (I see some market maker brokers that offer 1:1000 leverage too). This means that a trader is free to risk 500 times more money than his invested capital. Broker offers this leverage to the traders and if trader does not learn to use the leverage wisely, he is more than likely to never make a success of himself as a trader.
If you focus on safeguarding your initial capital you are less likely to fall prey to the leverage carrot as easily. Your thinking has to on the lines that even if you lose 3-4 trades in a row in the beginning you should have enough capital left of your own to be able to strike a few profitable trades and recover your losses with it.
Traders generally are advised to follow the 2 percent rule; according to which you should at no cost risk more than two percent of your trading account balance; and when you are entering into multiple trades you can at the most risk six percent of your trading account amount; if you are not into multiple trades then you should set six percent limit to your monthly trading losses. Don’t lose beyond six percent and be accurate about this calculation.
Another money management rule for Forex traders is that they should always focus on making more winning deals than losing deals. However, small the profit; profit is a profit nevertheless. Profit will help your account size grow like the hope of one big win never can.
So stick to small expectations and make your account grow little by little than making those flashes in the pan. In the long run they never work. Small steady profits are also good for your trading temperament. Sometimes bad trades mess up your spirit of trading and it can influence bad trades. So its better to avoid it.