Risk management is a critical topic every trader must learn regarding trading forex. Forex traders experience different emotions, from excitement to anxiety, disappointment, and elation while trading. All traders want to squeeze as much potential profit as possible out of each trade and, simultaneously reduce any potential loss. The primary reason forex traders lose money in trades is not due to a lack of knowledge of the market or inexperience but because they lack proper risk management skills. Therefore, to become a successful forex trader, the knowledge of managing risks in forex trading is a “must-have.”
Risk is a significant part of forex trading. If you cannot take risks, it is advisable to avoid trading entirely. You can place trades based on market analysis and speculations. Speculation in trading isn’t gambling but a part of risk management. In fact, it is better always to follow your intuition as a trader in every trade.
Top 5 Ways to Effectively Manage Risks in Forex Trading
1. Don’t Trade with Your Disposable Budget
A disposable budget is allocated for essentials like housing, transportation, utilities, etc. When you trade with your disposable budget, your emotions during trading tend to be heightened. This is because this budget is not money you can afford to lose.
If you place a trade with your house rent, for example, and you need to hold your position to make a significant profit; however, you may be forced to sell at a loss if your house rent payment cannot wait. This is why it is advisable to trade only with money you won’t need urgently.
Also, trading with a disposable budget makes traders impatient. So, you need to learn to be patient as a trader.
2. Use A Stop Loss
The importance of setting a stop loss in trading cannot be overemphasized. Successful traders lose money every time. The only difference between them and the unsuccessful traders is that they have built their portfolios so that their profit exceeds their loss at the end of every trading session.
A stop loss protects your trades from unexpected market movement by allowing you to set a predefined price at which the market automatically closes your position. For instance, when the market is going against you, and you stand a chance of making a loss, a stop loss helps to manage your risk by closing your trade when the asset hits your stop loss price.
However, you must note that stopping loss can sometimes make you lose profit too. This is because the market occasionally behaves erratically. For example, the market will rise immediately after the market hits your stop loss, making you lose out on your profit and, at the same time, make a loss. This can be very painful for traders because, in this case, they lose on both ends.
You should learn to set stop loss properly to avoid this situation. It is advisable to set your stop loss at a 2% margin for any given trade and never increase this margin. Whenever your trade rises after hitting your stop, loss is called Slippage In Trading.
3. Take Profits to Protect Your Portfolio
You must leave your emotions asides when trading to become a consistently profitable trader. Do not be greedy in trades. Avoid staying in positions for too long, hoping to bag more pips. Also, avoid exiting trades manually immediately when you notice the market is against you. Setting a predetermined price before going into any trade is always better.
The market moves in a zigzag pattern. It can neither remain down nor can it stay up forever. As the market is moving against you, have it at the back of your mind that it cannot stagnate and move in your favor once more. You can effectively ride market waves by taking profit orders, making a profit when required, and ultimately protecting your portfolio.
4. Be Smart About Position Sizing
Arguably, your position size in forex trading is more important than your entry and exit level. You are not following risk management rules if you set your position size too big or too small every time you trade.
Even though your level of risk tolerance depends on your personal determination and decision, risk management can help you establish the right position sizing.
It is typical among traders to commit a tiny percentage of their total account value to a single trade. However, you need to know both the monetary value of your desired position based on the value of your account to determine your position sizing.
You need to think deeply before you decide on your position size. Calculate and think properly before you make this decision, as it will determine how long a recovery will take when you take a big risk.
5. Manage Your Emotions
There is high volatility in forex trading. Trading can go up in a minute and go down in the next. As a trader, you need to be prepared for these changes. Forex trading will play with your emotions – no jokes. However, there is no cause for alarm. You are the key component that affects the success of every trade you make. Even though you don’t control the market, you can decide on your reaction.
The outcome of your trades will be affected if you let your feelings get in the way of your decision-making process. Even though following your intuition can be helpful, you should maintain a trading journal to help refine your trading strategy based on previous data.
Conclusion On How To Manage Risks In Forex Trading
Some traders are willing and capable of taking higher risks in forex trading than others. These set of traders have mastered trading and has their emotions in check. What works best in forex risk management will vary according to your preferences in trading.
The best trading tip for beginners is to reduce their risk and not rush into the market without proper analysis. To improve their expertise, beginner traders can start with demo trading, a risk-free trading environment.
Risk is intrinsic in forex trading. Nevertheless, as much as you can measure the risks in forex trading, you can manage them. Ensure you practice all the options above to manage risk in your trades as a forex trader effectively.