Forex trading is fast, easy and convenient. Trades are completed almost immediately, and profits readily available at one’s fingertips. However, the instant gratification and adrenaline rush can cause one to make rash decisions. Which can turn the speculative aspect of trading into gambling.
What then, differentiates speculating from gambling? The answer is the use of sound risk management strategies. This is what we will cover in this article.
1. Only risk what you can afford to lose
It may sound obvious, but as a Forex trader, you should only risk money that you can afford to lose. This is something that less experienced traders struggle with. Many get carried away when they make early profits. They increase their risk in hope of making a bigger profit, which can lead to huge losses.
An easy way to think of this concept is when gambling. In general, one does not place all their chips on a single bet. It is exactly the same with Forex trading. Remember, Foreign Exchange Markets are volatile. It is better to approach each trade with a conservative and calculated mindset. If you cannot afford to lose the amount of money you are trading, do not make the trade.
2. Manage your risk per trade
It is a good habit to consider your risk per trade. A good starting point would be 1% of your available capital for every trade. For example, you risk $100 per trade with a $10,000 trading account. This ensures that you have ample capital to work with in case of a losing streak.
While other trading variables change, it is important to keep your risk per trade constant. It takes a good amount of discipline to do so, especially when one is tempted by a winning streak. Be sure to select an appropriate risk per trade and keep to it.
3. Keep to a constant risk to reward ratio
It is important to understand what is a risk to reward ratio. It measures how much you are willing to risk to potentially earn a certain amount. Many market strategists recommend a risk to reward ratio of 1:3. For example, a risk to reward ratio of 1:3 suggests that an investor is willing to risk $1000 for the prospect of earning $3000. The purpose is to help manage the risk of losing money over time.
Let’s take a look at an example of the 1:3 risk to reward ratio carried out over 10 trades. Even if an investor loses 5 trades ($1000 each) and wins the other 5 ($3000 each), he would still make a total of $10,000 ($5000 in losses vs $15,000 in winnings). This ensures a higher chance of profit even if you are on a losing streak.
4. Use stop-loss and limit orders
The use of stop-loss and limit orders are another important strategy. A limit order allows an investor to set the minimum or maximum price that they would like to buy or sell at. A stop-loss automatically closes your position should the market move to a specified level. This allows you to minimize your losses and keep to your trading plan.
Stop-loss and limit order features are available on the Forex4you Desktop, Webtrader and mobile app platforms.
5. Make use of leverage
Leverage is another tool to take advantage of when you trade in the Forex market. Essentially, leverage involves borrowing money from your bank or broker to invest. A big benefit of the Forex market is the availability of high leverage. You can often get a much higher leverage than you would when trading stocks. For instance, leverage is commonly as high as 100:1. This means that you can trade up to $100,000 in value with $1000 in your account.
Many Forex traders use leverage to profit from small changes in currency pairs. However, it is important to know that high leverage can also be a disadvantage. Should the price go the other way, losses can be magnified just as much as your potential profits.
With any trading decision you make, there will be an element of risk. As the saying goes, “No risk, no reward”. It is then up to you to learn how to measure these risks and manage them. For beginners, it is advisable to first try out these strategies on a demo account — a feature offered by many major brokers, such as Forex4you.
Remember to pay attention to your trades on a regular basis too. Take down notes on what you did right and what you can improve on. Couple this with a disciplined approach and good trading habits, and you should see better results in the long run.
Forex Trading involves significant risk to your invested capital. Please read and ensure you fully understand our Risk Disclosure.