Forex risk management refers to a set of ideas that a trader can use to minimize risks when trading forex. Risk management is a crucial part of any forex strategy and is one of the main skills that you should learn to master from the very beginning.
The central concept behind any risk management strategy involves limiting your loss-making trades while maximizing your profitable trades. Forex risk management involves using stop losses, trading proper lot sizes, using leverage wisely, trading during specific hours, and buying the rumors.
1. Use Stop Losses
A stop loss is a trading technique that takes you out of losing trades at a predetermined level in order to limit your losses. Utilize stop losses to ensure a 1:1 risk-reward ratio and above in all your trades in order to limit losses and maximize profits on each trade. For example, if you’re setting your stop loss at 50 pips below your entry point, set your take profit at least 50 pips above your entry point.
A 1:2 risk-reward ratio and above will ensure that you remain profitable even if majority of your trades are losing trades. Using a 1:2 risk-reward ratio means that you should place your stop loss at 100 pips if you have a profit target of 200 pips and so on.
If you are a more aggressive trader, you can use a 1:3 risk-reward ratio, where you risk 100 pips for a profit target of 300 pips.
2. Use Proper Lot Sizes
Trading using proper lot sizes is crucial to your success as a trader. That’s because the lot size determines the value of each point of the currency pair you are trading. A standard lot typically refers to 100,000 units of the base currency you are trading. Therefore, trading a standard lot of the EURUSD currency pair puts the value of each point at USD 100.
The lot sizes you trade should be proportionate to the amount you are willing to risk on each trade, which is directly related to the size of your account and your risk appetite.
3. Control Your Losses
You should only risk 2% or less of your trading account on each trade. This will ensure that you can survive any losing streak while minimizing the drawdown on your trading account.
Remember: losses in forex trading are not linear. A 50% loss would require a 100% gain in order to recover your original trading account level.
4. Use Leverage Carefully
Most forex brokers offer trading with leverage, and with Exness traders can enjoy up to 1:Unlimited leverage. While trading with leverage is one of the great advantages of trading forex, it can also increase the risk of losses if used incorrectly. Leverage works as a ratio, meaning that if you trade with USD 10 at a leverage of 1:50 your market investment will be USD 500. This means that, if your investment moves in a favorable direction, your profits would be 50x bigger than they would have been without leverage. However this also means that your losses if the currency moves in an unfavorable direction would be 50x greater as well. Traders are therefore reminded to apply leverage with care.
5. Choose The Time Of Day That You Trade
Most traders tend to ignore the impact of the time of day that they trade. However, traders who are active during periods of less volatility tend to be more profitable than traders who trade during periods of high volatility.
The high volatility periods for different currency pairs vary, but can generally be summarized as the opening hours of the Asian sessions, the London/European sessions, and the New York/American sessions.
Experienced traders who are trading European currency pairs, such as EURUSD and GBPUSD, typically trade during off hours from 7PM to 11AM GMT. However, this data applies to range traders who trade following the existing trends, but might differ for traders using other trading strategies, such as scalping.
6. Buy The Rumor, Sell The News
Many traders like to stay abreast of news that affects the forex market, but this is very hard to do given that it is near-impossible to accurately predict what will happen at any given time across the globe. However, experienced traders typically keep abreast of economic releases from different countries, which generally have an impact on many currency pairs.
In most cases, markets typically discount the news based on investors’ expectations, which means that by the time the news is released, the big moves in the affected currency pairs would have already taken place. Therefore, it is important to make trades related to major news events way before the actual news is released.
As a trader, you should use the above risk management tips as part of your trading strategy to increase your chances of reaching your potential. The above list is not exhaustive, and skill only comes with experience. Trade with Exness today and start applying your newly learned principles!