The very first time I tried my hands at forex trading, I lost my entire start-up capital of 3,000,000 Naira in less than a week.
Why?
First of all, I had no business trading with a real account after practicing with a demo account for less than 2 weeks with success that led me to the wrongful estimation of my abilities or lack of it.
As a result of my nonexistent training and preparation for the market, risk management was not applied to my trades. How could I apply it when I was not aware of anything called risk management nor its application to position sizing.
I believed I had hit a gold mine. But, it was not to be as my entire savings of years past vanished into thin air faster than you could say “hocus pocus”.
Every trader that wants to last long in the industry must have very solid risk management. A lot of traders make the mistake of focusing on the profits they intend making while neglecting the protection of their capital.
It would be painful for you to lose your capital as I did earlier in my trading career so we will be taking a look at essential concepts and techniques to help you manage the amount of risk your trading capital is exposed to.
Why is risk management so important?
The Forex market is very volatile. Economic news, geopolitical events, and market sentiment cause massive price fluctuations that can lead to catastrophic losses even for experienced traders.
You should bear in mind that risk management helps traders to
- Preserve their capital
- Shield themselves from the psychological impact of unmanaged risks.
Controlling exposure with position sizing.
Position sizing is the very first and most important step in effectively managing your trades. The sizes of your trade positions should be directly proportional to your account size and the percentage of your account you are risking on the trade. You are protected from unnecessary risk when you determine the size of your positions this way.
Let me explain.
Let us assume you have $1,000 in your trading account, and you spot a BUY opportunity on EURUSD. You should not just choose a position size based on your feelings but instead apply risk management to calculate the ideal position size based on your account size and amount of risk you are willing to take on that trade.
Let’s say you risk 1% of your balance on every trade you take. 1% of the $1,000 in your trading account is $10. Risk management ensures that you do not lose more than $10 on the trade by the time it hits your stop loss.
All you need to do now is calculate your position size so that only the amount of money you are comfortable losing will be exposed to risk. On a $1,000 account trading EURUSD with a 50 pip stop loss and willing to risk just 1% of my capital, my ideal position size for the trade will be 0.02.
Calculating the right position size
Exness has provided a way for traders to manage risk easily and effectively with the use of their online trade calculator. Traders do not need to spend valuable time better used in executing trades on calculating position sizes.
Another way to manage your risks is by using a very good broker to trade. Exness comes highly recommended by me because they do not charge swap fees on trades held overnight or over the weekend. Swap fees eat into your profits, and adds to your losses. Open an Exness trading account today.
Always use a stop-loss
A stop loss is a very important part of risk management as it helps you cut your losses and exit trades at a predetermined price. Trading without a stop-loss exposes you to a very dangerous trading practice where you begin to hope that price goes in your favor instead of cutting your losses when market movements do not align with your analysis.
Do not take a trade if it is not worth the risk.
Not all trades are worth the risk but how do you determine the trades to let go? That is why the risk:reward ratio of every trade is important and should be put into consideration before placing a trade.
What is risk:reward ratio?
The risk:reward ratio is the ratio of potential profit weighed against the potential risk needed to make such profit. Most traders target to make a profit that is double the taken risk on their trades, which is a risk reward ratio of 1:2. Any trade that does not meet this requirement will be overlooked by the trader as taking the trade would violate an already laid out risk management strategy.
Put away your emotions.
Trading emotionally will only help you lose money and the more emotional you are with your trades the faster money would be lost. Fear and greed will make you take irrational decisions like exiting winning trades too early, holding on to losing trades, and using unnecessarily large position sizes in your trading.
To manage your account properly and with reasonable risk, your emotions have to be in check. Here are some things I learned the hard way which I believe every trader should take to heart.
- Stay disciplined. Stick to your plan and avoid panic.
- Losing is a part of forex trading and no trader is immune to it.
- Manage your losses, keep it small, and learn from it.
- Stick to your strategy even when it is not going well.
These rules are easier said than done and the ability to follow them are more likely to make you a successful trader more than any trading strategy you are going to learn because even the most accurate of strategies will fail without proper risk management.
There is no perfect strategy. Risk management protects your account from the inadequacies of your trading strategy. That is why it is so important and trading without a risk management plan is equal to throwing your money away.
If you are new to forex trading, then our beginner course “Forex 101: Essential Training for Novice Traders” is the perfect resource for you to start learning for free today.
2 Responses
This article is quite helpful, more like a reminder “stick to your game plan”….