The notion of trading is one that can be traced back to ancient times, while its fundamental principles continue to underpin the world’s financial markets of today.
This includes the concept of risk and risk management, which allows traders to minimise the threat of loss and make the most of their hard-earned capital. This applies whether you’re trading apples or investing in the foreign exchange, although the type of risk management strategies that you’ll deploy in the latter may be far more complex.
In this post, we’ll look at how you can implement a risk management strategy and navigate the fast-paced and challenging forex market.
1. Only Trade Money That You Can Afford to Lose
The best risk management strategy is proactive rather than reactive, with the most simple embodiment of this principle being that you should only trade with money that you can afford to lose.
This ensures that you’ll never invest outside of your means, while it’s also an easy to overlook rule amongst beginners who lack knowledge of the marketplace or are over-reliant on their instincts and emotions.
This requires stringent and realistic budgeting, as you need to determine a viable amount of capital to trade with before you start securing leverage and opening margin-based positions that are far larger than your initial deposit amount.
Fortunately, you can trade forex with a relatively small capital holding, although this may vary depending on the precise forex broker that you deal with.
2. Always Utilise Stop-loss and Limit Orders
On a similarly proactive note, you should also ensure that each of your forex orders are governed by stop-loss and limit orders.
Orders refer to instructions to your broker to place a trade when the price in the underlying market hits a certain level, while stop-losses can be imposed to automatically close positions once they’ve incurred a predetermined level of loss.
With these measures, you can simultaneously ensure that you enter the market at the optimal time while minimising losses in real-time, potentially optimising your profit margins in the future.
Stop-losses and similar measures will be tailored to suit individual positions, but the key is to ensure that they’re imposed in order to protect your hard-earned capital.
3. Set Your Risk/ Reward Ratio to a Minimum of 1:2
Knowing about the risk/ reward ratio (RRR) will definitely improve your chances of becoming profitable in the long-term, while augmenting the positive impact of setting stop-loss limits on your account.
In simple terms, a simple RRR measure compares the distance between your entry point and established stop-loss or take-profit orders, helping you to understand the precise value proposition of each individual position.
In general terms, scalpers and day traders should aim to have a minimum RRR of 1:2, while investors with a longer-term outlook and position traders will benefit from a wider ration of 1:3.