Risk management in forex is all about implementing pre-defined rules. As well as measures that further help traders to manage the negative effects of trade. To trade profitably, traders must adopt an effective and long-term strategy right from the beginning. In other words, traders must have a forex risk management strategy before they venture into forex trading. Here, discover more about effective risk management strategies and how you can determine your position size for any given trade.
Determine Your Position Size:
When it comes to day trading, the position size (also referred to as the trade size) is crucial when compared to the entry as well as exit points. You may have the best forex trading strategy in place but if the trade size or position size is too small or big, you’ll either end up taking too little or too much risk. Remember, when you risk way too much, you put yourself in a highly risky position and the funds in your trading account can evaporate quickly. Typically, micro lots constitute 1,000 units of your preferred forex currency, whereas mini lots account for 10,000 units. Similarly, standard lots consist of 100,000 units. Thus, to manage your risk effectively you must know your position size, which is determined using a position size calculator (http://riskcalculator.app/). This calculator not only helps you to calculate your position size automatically but also does it both quickly and precisely.
Set the Maximum Risk Limit For Every Trade:
The next step to managing risk and identifying the position size is to set the percentage that you will risk for every trade. For instance, if there is $10,000 in your trading account, then you can risk $100 per forex trade if you use the 1% limit. On the other hand, if you set the risk limit at 0.5%, then you may risk $50 for every single trade. Typically, professional or successful traders don’t risk more than 1% of their trading account. Traders can also utilize a fixed amount of dollar, which equals to 1percent of the entire value of the trading account or lesser. For instance, you may risk $75 for every trade if your trading account balance amounts to $7,500 or higher.
Thus, while other variables can change, trading account risk must be fixed or constant. Ideally you should not risk 5% on one trade and 1% on another.
Set the Risk-Reward Ratio:
When it comes to forex trading, you should be willing to take only as much risk as is worthwhile. Typically, you will want to profit more and keep your losses to the minimal. To do this, you must set the risk-reward ratio as that will help you to quantify your trade’s worth. To find this ratio, you must compare the money that you are willing to risk on trade to your potential gain. For instance if you fix the maximum risk or loss for your forex trade at $200 and the potential profit is $600, then your risk-reward ratio will be 1:3. Therefore, if you place ten different trades by applying this particular ration and if only three of them are successful, then you will have earned $400 despite being partially right.
Don’t Forget the Stop and the Limit:
Given that the forex trading market is usually volatile, it is crucial to choose the entry as well as the exit points of the trade before opening a position. The ideal way to do this is by using different stops as well as limits.
- In case of a ‘normal’ stop, your position will be closed automatically when the market goes against you. But, there isn’t any guarantee if there is slippage.
- In case of a guaranteed stop, the position will be closed at the exact price specified by you, while eliminating the risks of slippage.
- Trailing stops follow positive movements in the price and close the position when the market is not moving in a favorable position.
- A limit order follows the profit target as well as closes the position once the price reaches your selected level.
Taking Partial Profits:
At the time of opening a trade position, a trader usually sets a profit target at the back of his/her mind. Typically, this target is taking profit for the trade position. However sometimes traders fix several profit targets/limits for a single trade position and close it partially once every profit limit/target has been reached. It is called taking partial profits or half the profit targets and is a common practice among traders around the globe. There are numerous reasons why a trader may be interested in taking partial profits. To begin with, they are looking to safeguard their funds from the reversal. Remember, reversals can take place anytime while trading, and that is precisely why no forex chart ever features a smooth line (i.e. there are always dips and tops on the chart).
So, if you hold a buy trade position, taking partial profit will allow you to limit the losses if there is a reversal. Apart from this, taking and securing partial profits helps you in opening other promising trade positions. This can be extremely useful for forex traders who have limited funds at their disposal. Lastly, taking partial profit is also useful when fresh economic data/figures are likely to be announced and your position is still be traded. In case your position is positive, you could take profits as well as later place a stop loss and take your profit at the right levels.
To sum up, forex risk management entails keeping the risk for every trade to the lowest or avoiding large losses. The position size of your trade is an important aspect of forex risk management as the smaller your lot size, the less is the value of every pip, and thus your losses are also minimal. Remember, it is your losses that wipe out the capital funds in your account and negatively impact your confidence, eventually affecting your career in the forex market.