3 Important Ways to Proper Risk Management in Forex Trading
No forex strategy is 100% profitable. Even professional fund managers are not profitable all the time. We need to embrace losses in our trading; there is now way around it. Learning how to manage them effectively is a prerequisite in order to be consistently profitable. This article will show you three ways for minimizing risks in your forex trading, improving your analysis, and significantly reducing the drawdown of your trading account. So, here they are:
Stick to a Profitable Risk/Reward ratio
The biggest mistake traders are making in their early trading career is not to monitor the risk/reward ratio for their positions. You don’t need a 100% win ratio to be profitable, the most profitable trading systems actually aim for a win ratio of only 55-60%. You can even be profitable with a 50% win ratio, as long as your winning positions are larger than your losing ones.
Here, the risk/reward ratio comes into play. Imagine you open a position with a possible profit target of 1000$. You need to risk less than the possible profit you can make; otherwise your trading account will be wiped out quickly. A solid risk/reward ratio you should target is 1:2, which means you risk half the amount you can gain. This way, for each winning position, you can have 2 straight losses and still be on the break-even point.
Keep your trading charts clean
Almost every new forex trader is tempted to use all available technical indicators of his trading platform, forming a big mess on the chart. Although some indicators can be useful for a particular trading style, less is usually more when it comes to making an analysis. Also using indicators from the same group, like oscillators, will create redundant information and mess up the chart. An example would be using MACD with moving averages on the chart. This is not useful as the MACD itself is based on moving averages and will provide the same information like the moving averages from the chart. An even more confusing situation is when the used indicators deliver opposite signals.
A chart should be easy to read, without unnecessary information. Any indicators which are redundant and don’t add to the improvement of the analysis should be removed. Beside the indicators, the chart itself should also be user-friendly, with adequate colors and fonts, and the chart type used should be straight-forward and deliver useful information like open, high, low and close prices. I usually like simple black-white (or red-green) candlestick charts, and use just one or two indicators depending on the strategy.
Your risk rises with the leverage
Unlike other markets, forex is very attractive for newcomers because of the high leverage which is offered by brokers. There is a potential of making huge profits with a relatively small initial investment. Although leverage can amplify your profits if used properly, it can also increase your losses to the same extent. Traders should utilize the leverage according to the account balance they have on hand. Any leverage above 10:1 is usually considered too risky by professional financial firms, while traders on the forex market have the opportunity to trade with leverage up to 400:1! Combined with a lack of experience, this trading style will wipe out your trading account at the very beginning of your trading journey. If we stick to the 10:1 leverage rule, a trader with a $5,000 trading account will open positions worth a maximum of $50,000, which equals to half of a standard lot, or roughly 5$ per pips. Also take into account the maximum amount you are risking per trade. A stop-loss of 20 pips, if triggered, would make a loss of about $100 for the trader, which equals about 2% of the trading account. Taking the lessons from the first point of this article, the potential reward for such a position should be 40 pips or cca. $200.
There are many other ways to minimize your trading risk, but these three are considered as the most effective. Especially for newcomers to the trading world, mastering these simple yet effective rules will significantly improve your trading results. Monitor your risk/reward ratio, keep your charts clean and use a reasonable leverage, and you will feel the difference pretty soon.
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