Managing Risks in Trading
Forex trading can be very profitable but also very risky. When a trader does not manage the risk, and follow some simple rules to do so, he is basically gambling. Trading can be much less of a gamble when you use common risk management techniques. Risk management is all about controlling the losses. The losses are inevitable but if you control them, you limit the risk involved.
There are many factors in Forex trading that increase your risk and obviously managing those factors will help mitigate the risks. Some of the factors that can increase your risk include using leverage, liquidity and high risk per trade. Taking on some risk is the only way to profit but watching these factors can help you reduce the risk without greatly reducing the potential profits.
The most fundamental rule that will help you manage your risk is NEVER risk more than you can afford to lose. If you lost the trade, would it put you out of the market completely or would you be able to continue trading? That is an important question to ask yourself every time you open a position. This is especially crucial when using leverage. Using leverage that you cannot afford to lose is a very common but extremely costly mistake.
Another extremely important rule of risk management is trade with your strategy, not your emotions. Emotion and impulse will almost always steer you towards a much riskier Forex decision than a tried and tested trading strategy. Using a strategy that is well planned, tested and tweaked can protect you from many losses that you might incur if you acted on adrenaline, or impulse.
Stop losses are essential to any Forex risk management plan. Stop losses are the safety net that Forex traders need to keep themselves from falling too far. Once you decide on a stop loss, stick to it. That is how it is meant to be used. Set it at a certain level and don’t move it so that it can do its job properly.
Diversification is your friend. Make sure all your assets are not tied up in only one type of currency or even only one type of investment such as Forex trading. The idea behind this suggestion is that if one type of currency loses value, hopefully any others you hold, will not. The adage against putting all of your eggs in one basket is what this method of managing risk is based on.
Making sure your availability matches the type of trading you are doing also will reduce your potential losses. When your timing is off you will be most likely to have losing trades. Watching closely for the right time to enter or exit a trade is essential to managing your portfolio and ultimately is a large part of which way the trade goes. If you might not be available to watch carefully to exit at the right time, that is not the time to enter a trade.
Knowledge is the best weapon against losses and knowing the best way to mitigate your risk is an important part of Forex success.