Risk management is a combination of ideas to control the risk of trading. Without a good risk management it is not possible to succeed in trading the financial markets.
Some of the examples how to manage trading risk is to:
- Open smaller trade sizes which will decrease the losses per trade.
- Avoid certain trading hours to open orders due to news announcements or expected higher volatility
(for example during roll-over times).
- Have stop-loss orders always in place for all open orders.
Risk per trade
It is important to control your losses and open smaller trade sizes to avoid big swings in your account equity. Some analysts recommend to risk only 1% or 2% of your account equity per each trade. This way you have more chances to stay in the business over a long-term period.
For example, if you have $1,000 of equity on your trading account and you risk only 1% of your account equity on any given trade then the maximum you can lose per trade is $10. A loss per trade of 1% would mean that you can be wrong 100 times in a row before you exchaust the majority of your account equity.
Each trader has to determine the most convenient risk per trade percentage or any other risk management component individually depending on his or her trading strategy, liquid assets, trading account size, etc.
One of the benefits of trading the Forex markets is the availability of high leverage. Using leverage of any amount means borrowing money from the broker. Using high leverage can result in big swings in the gains but at the same time can bring also devastating losses. The higher the leverage you use the more risk you have on your trading account.
For example, a leverage of 1:100 means that with a deposit of $1,000 you can open a maximum position of $100,000. A one pip loss in this situation would result in a trading loss of $10 whereas a 50 pips loss would result in a loss of $500. Should the market move 1% against your entry point then it is theoretically possible that you lose 100% of you initial investment. In some circumstances it is also possible to lose more than 100% of your account equity if you open a maximum allowed position and the market opens with a gap on Sunday night.
We generally recommend our clients use lower leverage in order to avoid higher risk.
Stop and limit orders are an integral part of risk management. Stop loss orders are used to limit losses in a trade or to lock in profits in the case that the price of the currency pair moves against the position of the trader. Good traders use always stop loss orders to limit their losses because this way they preserve their account equity which they can then employ in other trades that could end up in profit.
The information provided here has been produced by a third party and does not reflect the opinion of Tickmill Europe Ltd (ex Vipro Markets Ltd). Tickmill Europe Ltd (ex Vipro Markets Ltd) has reproduced the information without alteration or verification and does not represent that this material is accurate, current, or complete and therefore should not be relied upon as such. The Information is not to be considered as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any particular trading strategy. We advise any readers of this content to seek their own advice. Reproduction or redistribution of this information is not permitted.