Lesson 33 – Risk Management Basics, A Guide for Forex Traders
Successful forex trading is all about keeping to a strict pre-set plan and managing your risk.
If you suddenly start trading with more capital than you are comfortable with, or switch to a strategy you haven’t practiced and tested before, you will overexpose yourself to things you’re not prepared for.
In order to help avoid getting yourself into inconvenient situations, let’s look at some areas of risk management you should implement to help protect yourself.
It’s best to think of trades as relative to your current trading balance rather than in absolute times. It’s a big difference losing a trade worth £10 is 10% of your trading balance gone or 0.1%.
Once you understand this, it’s really important that you set a clear percentage of your trading balance that you are willing to expose on each trade.
This will help you then choose what size of lot you will be trading with for your currency pairs, and the number of positions you will take.
A good percentage to risk on every trade that most veteran traders use is 1% or less.
So if your account balance is worth £20,000, you shouldn’t be exposing more than £200 per trade.
Whatever the final risk exposure you choose, make sure you stick to it. Keeping consistent with all of your trades is crucial to improving and ensuring consistent returns.
Implementing stop losses and managing pip risk.
Since we have now set the risk exposure and position size we are allowed to have per trade, we can now figure out where to set our stop loss.
Our stop loss should always be set at a designated amount away from the entry point of our trade, which essentially represents the amount of risk we are willing to take on that trade.
So, to set this, we should be aware of what one pip movement on that trade is worth, so we can implement our stop losses in relation to it.
So, let’s imagine if we have a position where one pip is worth £2 to us and our account balance is worth £20,000, then using a 1% risk tolerance, our stop loss should be set to 100 pips.
This is just a basic way of understanding stop losses, we will go over them in more detail in the next lesson.
When to take profit
Where to exit our trades in order to secure our profits is one of the most difficult things in forex trading. For this, you will need to use your trade research and indicators to establish exit points for our trades.
When you enter trades, you should always do so with a pre-set plan of where to enter and exit in order to stop losses or secure profit.
This is just a casual reminder. We will cover this in much more detail in a later lesson, so be sure to check it out.
We’ve probably mentioned this multiple times in lessons so far, but it can’t be said enough. Staying disciplined and consistent in everything you do it super crucial. Stick to your risk management and position sizes.
Never deviate away from them unless you want to plan a total shift and have pre-tested things first.
Even if you do plan a shift, make sure you stick to it afterward. You won’t get optimal results by flip-flopping the whole time. You will end up just making erratic decisions. Stay consistent.
Why is risk management important?
Keeping to a good risk management strategy is one of the key things you need to do if you want to trade successfully, and this is why.
I guarantee you will make mistakes. Whether it be misreading a number, drawing your support and resistance lines incorrectly, clicking the wrong buttons, or even just choosing a bad timing, risk management will protect us.
If you don’t have proper risk management in place, these types of mistakes will slowly eat away at your account balance and ultimately cripple you completely.
Even if you don’t necessarily make a mistake and just bad luck happens, then risk management will protect you from those too.
Basically, risk management will protect you from ever being in the situation of having your account wiped out.
Overall, sticking to a clear risk management strategy is key for any successful trader. It will make sure that you are protected and that in the long run, you will succeed.
So, trade responsibly, consistently, and in a disciplined manner and you will succeed over time.
So that’s it for this lesson. In the next lesson we will cover “Stop-loss” for forex traders in more detail. See you there!