News & Events
Few Things About Smart Risk Management Every Forex Trader Should Know
- January 5, 2016
- Posted by: HumbleTraders
- Category: Forex Blog
We take risks every time we step outside our door in the morning. We have to fear catching colds, natural disasters or unexpected accidents. Just the act of getting in the car in the morning and taking the highway to work is a risk that involves the potential for flat tires, fender benders and wrecks.
However, if you don’t get up and go in the morning, you will miss out on the chance to gain any type of reward. The same principle holds true when it comes to forex trading. There are things traders must be vigilant about if they want to protect themselves from losing money unnecessarily in the foreign exchange market.
Many traders get caught up in fads and do not pay attention to proper money management. As a result, the lose money that never had to be lost.
The two biggest reasons why people lose money are improperly used stop-losses and trading positions that are too large.
The problem of losses is especially big among novice traders who lack the ability to properly plan a long-term strategy. Do you want to become a better trader?
Learn about the five key elements of risk management forex traders must know to become successful in the long run.
It is crucial to place stop-losses if you want to be a successful trader. A stop-loss is an order placed with a broker to buy or sell a stock once it reaches a predetermined price point.
Think of a stop-loss as a seatbelt for your portfolio that is designed to keep you in your seat if your stock goes over a cliff. In financial terms, a stop-loss is set up to limit your loss amount on a security deposit.
One thing you have to keep in mind is that losses will occur no matter what. They are cost to this business. While you can’t stop them from happening, you can limit the amount you’ll lose.
You can use a stop-loss to curb your losses by setting the order for amount of pips away from your entry point or a certain percent below the price you purchased the stock for. Taking this action will limit your total loss to just the amount you set it to.
While it can be hard to take a hit, it is far less painful than experiencing a deeper dip.As prices trend, setting stop loss will limit amount of losses you have.
If you are being stopped out, the price had reversed and it is likely building a new trend in the opposite direction. You need to get out!
The biggest rule to follow when pursuing profits is to leave your emotions behind. It is important to have a predetermined exit strategy in place so emotions don’t cloud your judgment and cause you to react impulsively.
Traders who act on emotion can expect to walk away with lower profits than those who trade based on logic and discipline. The trick is to let winners run and make you some money. While it may be tempting to walk away from the table once you’ve made a small profit, it is important to resist the urge to be content with small gains.
Train yourself to avoid manually exiting a trade whenever you see things move against you. The zigzag motion of the market means it’s probably only a matter of time before things swing back in your favor.
A better strategy is to wait for the market to take you out.
Make a plan to set your trades and stay committed to letting the ebb and flow of the market determine whether you make a tidy profit or a small loss.
Move your stop losses closer to new lows/highs printed by the price. This way you lock in more profits and ride the trend.
In the chart below, trader moved take profit levels after the price action produced lower high within the uptrend. He was able to ride most of it with small risk while collecting interest.
Size is a big factor when it comes to making a profit in forex trading. It is important to avoid risking more than 1 percent to 2 percent of a trading account at one time.
It is important to always remember that increasing lot sizes directly increases the amount of risk you’re exposing yourself to. In fact, increasing risk too greatly and too soon is that primary reason why accounts blow out. Establishing your position size should be done with much thought and preparation. Take time to do some calculations that will help you determine how long it will take you to recover your equity if you risk 5 percent or 10 percent at a time.
A Simple graph below will show you the recovery process after risking certain amount
Be Realistic About Your Ratio of Risk to Reward
You need to find the right ratio of risk and reward if you’re serious about trading. Your sweet spot will depend on a number of factors that are personal to you. For instance, a ratio of two to one will require a trader to have an accuracy rate of 40 percent in order to make a profit.
If you risk twice as much, you’ll need to have an accuracy rate of 75 percent in order to make a profit.
Can you realistically expect to have an accuracy rating of 75 percent? For almost all traders, the answer is a resounding no.
It is unrealistic for a trader to assume that they will be accurate more than half the time.
You should never base your ratio on the assumption that you can have an accuracy rating more than 50 percent.
Be Ready for a Losing Streak
It’s important to think of investing as a race rather than a sprint. It is important to prepare yourself mentally and financially for losing streaks. In fact, you can expect to experience 10 losing trades in a row at any given time if you will be placing thousands of trades over the course of a few years. It is important not to let discouragement and unrealistic expectations leave you vulnerable to impulsive trading techniques.
If you want to trade for the next 10 years, how many traders do you think you are going to place? It will be 1000s!
Prepare to get 10 losses in a row. It will happen!
Stay Alert and Avoid Mistakes
Being an investor is like signing up to be a lifelong student of the financial world. You have to continuously seek out market knowledge and stay educated on the factors that affect what’s happening to your money.
The most valuable lesson of all to take away in order to be a successful long-term forex trader is that the biggest hurdles to overcome in the financial world are often the emotional ones.
Arming yourself with a logical, systematic plan is the best way to make sure you don’t make a foolish decision in the heat of the moment.
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