Risk management in forex (Part 2)

Risk management in forex
Risk management in forex
Trading in forex could be very profitable, but sometime volatility in this market causes unbearable losses. To protect your trading portfolio from any loss, a set of rules and instructions shall be obeyed. These rules are referred to as risk management. Using risk management techniques, increases the potential profitability of trading while minimizing the risk.

Fundamentals of risk management in forex

You should specify your trading volume at the first step. As you may already know, a lot of trades shall be carried out in order to reach profit. The ability to trade in mini-lot and micro-lot is available for investors. Therefore, you shall learn to specify the amount you want to trade first. Specifying a reasonable volume, prevents you from trading too much. 1 standard lot equals 100,000 units of the currency pair you are trading. Mini-lot and micro-lot also indicate 10,000 and 1,000 units, respectively.

Use stop loss order properly

According to your strategy, you can place stop loss differently. You may decide to place your stop loss in a fixed distance from your entry point, or place it specifically according to each trade. If you set your stop loss differently for every trade, you should know where to place it. In fact, the stop loss order specifies where to exit the trade, if the trade moves in the opposite direction.

The 1.5% rule in risk management

To minimize your risk, it is a good practice not to risk more than 1.5% of your total capital in each individual trade. Keep in mind that loss is an inevitable fact in forex trading. Therefore, you should assure that this loss is minimized and doesn’t lead to total loss of your capital. As mentioned above, you have already learned how to place a stop loss and adjust your trading volume, therefore make sure that you don’t expose more than 1.5% of your total capital to risk in each trade. For example, if the total size of your trading capital is 10,000 U.S Dollars, you shall not risk more than 150 U.S Dollars in each individual trade.

Success rate

At first, you should specify how successful is your trading strategy, because this strategy may earn you a lot of profit or make your capital disappear at once. For example, if you review the last 100 trades you have carried out and 40 of them were profitable, the success rate of your strategy is approximately about 40%. The success rate of your strategy is better to be more than 50%. However, lower success rate does not mean absolute loss, because you can adjust your risk/reward ratio accordingly and make a 40% success rate strategy to be also profitable.

Risk/reward ratio

The risk/reward ratio is one of the most important factors that you should define in your forex risk management. This ratio is mostly used when placing T/P and S/L levels. The risk/ reward ratio shows the amount of risk you are willing to take to gain a certain amount of profit. For example if you are willing to risk one U.S Dollar to gain one U.S Dollar, your risk/reward ratio would be 1:1. If the amount of risk lowers, as the amount of expected gain remains still, the risk/reward ratio grows. It is recommended to choose a ratio about 1:1, 1:2 or even 1:3. This way even if your success rate is at least 50% you would be a profitable trader overall.

What to do before entering the market

Money management in forex shall be carried out before opening a position. All aspects such as trading volume, entry point, S/L and T/P location, etc. shall be determined before entering a trade. Try to make sure that this trading strategy is profitable. Your trading plan will tell you how you should adjust different parameters before entering a trade.

Generally, you could use two approaches to enter a trade; shotgun and sniper. In sniper approach, the most suitable spot for entry is specified and in the shotgun approach the total capital of the investor is divided up to smaller portions. Imagine you want to trade 1 lot; instead of opening a position with the volume of one lot, you could divide it up to five positions with 2 mini-lot volume and enter the market at suitable entry points.

What to do if the market moved against your position

A part of money management in forex focuses on managing positions at loss. Imagine you have a 60% successful trading strategy, in this case the total loss rate is 40%. If you would be able to recover half of the loss, you would only end up with 20% loss.

Several methods could be used to recover loss, hence protecting the capital from disappearing. To do so, you can average-up your entry point by adding to a losing position. For example if you have opened a position with 0.1 lot and lost 10 pips. Therefore you need to add another 0.1 lot to this position. Ultimately, if the position moves 5 pips in your favor, you could recover the amount you lost in the first place. In fact, you have lost 5 pips in the first trade and gained 5 pips in the other.

Use Hedging

Hedging in forex means opening a position, opposite to the existing one, which is a method for money management in forex. Imagine you have entered a trade in USD/EUR currency pair, meanwhile important economic data gets published and influences the exchange rate of USD/EUR. To prevent loss, you could open a position in the opposite direction with the first one. This causes the profit and loss of your trade to minimize. Then you could close both positions when the market got calm. When you have two positions in opposite directions, you will gain profit in one, while loosing in the other; therefore you are basically suspending your trade until you could evaluate the market once more and make trading decisions.

The art of making profit in forex

Making profit in forex is possible through precise strategy implementation and proper data analysis. Taking out your profit too late could lead to loss and taking it out too soon could make you loose a great trading opportunity, hence making less money in the process. Take the following recommendations under consideration for gaining more money:
  • Trading with at least risk/reward ratio of 1:5
  • When you sensed that your capital is in danger, use one of the loss recovery methods mentioned above
  • Let your winning trades to go on a little more. When you are trading in a volatile market and the amount of profit is significant, don’t save your profit too soon

Bottom line

One of the most important factors in financial markets is money management. There is a famous saying that says “A bad trader loses money with a great strategy and a good trader gains more money with a bad strategy”. If you have a good strategy but you are not able to protect your capital, you will probably just loose your money.

If you want to properly implement money management in forex, take the following recommendations under consideration:
  • Know the basics
  • Evaluate the market before entry
  • Specify the entry points using a successful strategy
  • Manage loosing trades
  • Maximize your profit
  • Practice money management and earn experience

Aron Groups Broker offers several pending orders, S/L and T/P orders and a lot of technical indicators through its powerful trading platform; MetaTrader5. You could easily apply your risk and money management criteria, when trading in this platform, hence you will have no concerns when you are not able to monitor your open positions constantly.

Written by: Mohsen Mohseni (Aron Groups).
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