Understanding Forex Risk Management

[ellliottt]

Trading is the exchange of goods or services between two or more parties. So if you need gasoline for your car, then you would trade your dollars for gasoline. In the old days, and still in some societies, trading was done by barter, where one commodity was swapped for another. A trade may have gone like this: Person A will fix Person B's broken window in exchange for a basket of apples from Person B's tree. This is a practical, easy to manage, day-to-day example of making a trade, with relatively easy management of risk. In order to lessen the risk, Person A might ask Person B to show his apples, to make sure they are good to eat, before fixing the window. This is how trading has been for millennia: a practical, thoughtful human process.

 

This is Now

Now enter the world wide web and all of a sudden risk can become completely out of control, in part due to the speed at which a transaction can take place. In fact, the speed of the transaction, the instant gratification and the adrenalin rush of making a profit in less than 60 seconds can often trigger a gambling instinct, to which many traders may succumb. Hence, they might turn to online trading as a form of gambling rather than approaching trading as a professional business that requires proper speculative habits. (Learn more in Are You Investing Or Gambling?)

 

Speculating as a trader is not gambling. The difference between gambling and speculating is risk management. In other words, with speculating, you have some kind of control over your risk, whereas with gambling you don't. Even a card game such as Poker can be played with either the mindset of a gambler or with the mindset of a speculator, usually with totally different outcomes.

Betting Strategies

There are three basic ways to take a bet: Martingale, anti-Martingale or speculative. Speculation comes from the Latin word "speculari," meaning to spy out or look forward.

 

In a Martingale strategy, you would double-up your bet each time you lose, and hope that eventually the losing streak will end and you will make a favorable bet, thereby recovering all your losses and even making a small profit.

 

Using an anti-Martingale strategy, you would halve your bets each time you lost, but would double your bets each time you won. This theory assumes that you can capitalize on a winning streak and profit accordingly. Clearly, for online traders, this is the better of the two strategies to adopt. It is always less risky to take your losses quickly and add or increase your trade size when you are winning.

 

However, no trade should be taken without first stacking the odds in your favor, and if this is not clearly possible then no trade should be taken at all. (For more on the Martingale method, read FX Trading The Martingale Way.)

 

Know the Odds

So, the first rule in risk management is to calculate the odds of your trade being successful. To do that, you need to grasp both fundamental and technical analysis. You will need to understand the dynamics of the market in which you are trading, and also know where the likely psychological price trigger points are, which a price chart can help you decide.

 

Once a decision is made to take the trade then the next most important factor is in how you control or manage the risk. Remember, if you can measure the risk, you can, for the most part, manage it.

 

In stacking the odds in your favor, it is important to draw a line in the sand, which will be your cut out point if the market trades to that level. The difference between this cut-out point and where you enter the market is your risk. Psychologically, you must accept this risk upfront before you even take the trade. If you can accept the potential loss, and you are OK with it, then you can consider the trade further. If the loss will be too much for you to bear, then you must not take the trade or else you will be severely stressed and unable to be objective as your trade proceeds.

 

Since risk is the opposite side of the coin to reward, you should draw a second line in the sand, which is where, if the market trades to that point, you will move your original cut-out line to secure your position. This is known as sliding your stops. This second line is the price at which you break even if the market cuts you out at that point. Once you are protected by a break-even stop, your risk has virtually been reduced to zero, as long as the market is very liquid and you know your trade will be executed at that price. Make sure you understand the difference between stop orders, limit orders and market orders.

 

Liquidity

The next risk factor to study is liquidity. Liquidity means that there are a sufficient number of buyers and sellers at current prices to easily and efficiently take your trade. In the case of the forex markets, liquidity, at least in the major currencies, is never a problem. This liquidity is known as market liquidity, and in the spot cash forex market, it accounts for some $2 trillion per day in trading volume.

 

However, this liquidity is not necessarily available to all brokers and is not the same in all currency pairs. It is really the broker liquidity that will affect you as a trader. Unless you trade directly with a large forex dealing bank, you most likely will need to rely on an online broker to hold your account and to execute your trades accordingly. Questions relating to broker risk are beyond the scope of this article, but large, well-known and well capitalized brokers should be fine for most retail online traders, at least in terms of having sufficient liquidity to effectively execute your trade.

 

Risk per Trade

Another aspect of risk is determined by how much trading capital you have available. Risk per trade should always be a small percentage of your total capital. A good starting percentage could be 2% of your available trading capital. So, for example, if you have $5000 in your account, the maximum loss allowable should be no more than 2%. With these parameters your maximum loss would be $100 per trade. A 2% loss per trade would mean you can be wrong 50 times in a row before you wipe out your account. This is an unlikely scenario if you have a proper system for stacking the odds in your favor.

 

So how do we actually measure the risk?

 

The way to measure risk per trade is by using your price chart. This is best demonstrated by looking at a chart as follows

 

 

Figure 1: EUR/USD One-Hour Time Frame

 

We have already determined that our first line in the sand (stop loss) should be drawn where we would cut out of the position if the market traded to this level. The line is set at 1.3534. To give the market a little room, I would set the stop loss to 1.3530. (Learn more about stop losses in The Art Of Selling A Losing Position.)

A good place to enter the position would be at 1.3580, which, in this example, is just above the high of the hourly close after a an attempt to form a triple bottom failed. The difference between this entry point and the exit point is therefore 50 pips. If you are trading with $5,000 in your account, you would limit your loss to the 2% of your trading capital, which is $100.

 

Let's assume you are trading mini lots. If one pip in a mini lot is equal to approximately $1 and your risk is 50 pips then, for each lot you trade, you are risking $50. You could trade one or two mini lots and keep your risk to between $50-100. You should not trade more than three mini lots in this example, if you do not wish to violate your 2% rule.

 

Leverage

The next big risk magnifier is leverage. Leverage is the use of the bank's or broker's money rather than the strict use of your own. The spot forex market is a very leveraged market, in that you could put down a deposit of just $1,000 to actually trade $100,000. This is a 100:1 leverage factor. A one pip loss in a 100:1 leveraged situation is equal to $10. So if you had 10 mini lots in the trade, and you lost 50 pips, your loss would be $500, not $50.

 

However, one of the big benefits of trading the spot forex markets is the availability of high leverage. This high leverage is available because the market is so liquid that it is easy to cut out of a position very quickly and, therefore, easier compared with most other markets to manage leveraged positions. Leverage of course cuts two ways. If you are leveraged and you make a profit, your returns are magnified very quickly but, in the converse, losses will erode your account just as quickly too. (See Leverage's "Double-Edged Sword" Need Not Cut Deep for more.)

 

But of all the risks inherent in a trade, the hardest risk to manage, and by far the most common risk blamed for trader loss, is the bad habit patterns of the trader himself.

 

All traders have to take responsibility for their own decisions. In trading, losses are part of the norm, so a trader must learn to accept losses as part of the process. Losses are not failures. However, not taking a loss quickly is a failure of proper trade management. Usually a trader, when his position moves into a loss, will second guess his system and wait for the loss to turn around and for the position to become profitable. This is fine for those occasions when the market does turn around, but it can be a disaster when the loss gets worse. (Learn to overcome this big hurdle in Master Your Trading Mindtraps.)

 

The solution to trader risk is to work on your own habits and to be honest enough to acknowledge the times when your ego gets in the way of making the right decisions or when you simply can't manage the instinctive pull of a bad habit.

 

The best way to objectify your trading is by keeping a journal of each trade, noting the reasons for entry and exit and keeping score of how effective your system is. In other words how confident are you that your system provides a reliable method in stacking the odds in your favor and thus provide you with more profitable trade opportunities than potential losses.

 

Conclusion

Risk is inherent in every trade you take, but as long as you can measure risk you can manage it. Just don't overlook the fact that risk can be magnified by using too much leverage in respect to your trading capital as well as being magnified by a lack of liquidity in the market. With a disciplined approach and good trading habits, taking on some risk is the only way to generate good rewards.

[torykjzj0]

 

Good beauty routines can be enjoyable; however, some are simply frustrating. The tips here should help educate you in applying the perfect techniques to your beauty routine.

 

Use Vaseline for your eyebrows. Apply it just before bedtime. This will give you healthy looking eyebrows that shine. Don't get the Vaseline anywhere else, though, as it could cause breakouts.

 

Conditioner shouldn't be used daily for thin hair. In fact, using it once or twice a week would be plenty. This stuff will weigh your fine hair down and make it look dead and dull. So use conditioner sparingly if you want hair that looks bright and shiny.

 

Michael Kors Outlet Before bed you should apply your base coat, color polish, and top coat so it can set overnight. It's okay if it ends up not being very neat and gets on your skin. You are going to shower when you get up anyway, so use this opportunity to simply wash off the excess nail polish. Use this easy pedicure or manicure technique whenever you are pressed for time!

 

Before you adhere fake eyelashes, be sure to test for allergies. First, use the glue on another part of your body to test for an allergic reaction. Cover the area after testing to ensure an uncontaminated sample.

 

The beauty products you own will last longer if kept refrigerated. By placing them in the refrigerator, you will lengthen their shelf life. By keeping cosmetics such as lotions and oils in your refrigerator, you can keep them from melting or thinning in hot weather. Your skin will also enjoy the cooling effect.

 

You can put your moisturizer in an empty jar or tube of lip gloss. This perfectly portable container can be stashed in your purse, car, travel bag or even your desk drawer at work. Use a dab of moisturizer when your skin is dry.

 

Regularly exfoliate your skin, especially your face. Exfoliating your face takes off the top layer of dead skin cells, revealing the smoother, healthier skin underneath. If your facial skin is especially dry, you can exfoliate a few times a week. This will make your face appear more radiant and fresh and will prevent buildup of oils and dirt.

 

Eating healthy foods directly correlates with having healthy hair, skin and nails. This is another way that beauty comes from within. Your diet needs to be full of nutrients. You should eat high levels of zinc, iron, and whole grains in order to have healthy skin and nails.

 

Hair care is an important component of a mans beauty care. If your hair is dry, be sure to use a good, nourishing conditioner.

 

While beauty is in the eye of the beholder, there are certain factors that are true for everyone. Now, your job is to apply the information from this article to your own beauty routine.

 

[mesbakh]

forex is high risk high return. never tryto trader alone at home except acconpined with expert trader.

[shoaybkhan]

Forex trading may not be suitable for all investors, therefore ensure you fully understand the risks involved, and seek independent advice if necessary.

[euro]

Good article indeed. We should look at our risks and lower them at all possible. I do this by only trading with the best pairs that have high volumes and in demand all the time. I also trade with low spread and also only in 2 market overlap sessions that will yield more demands and I only trade during open market hours like London and NYC, as these two are very powerful. 

[Bagus]

traders focus is on how to reduce the risk of trading for the bus in the trade benefit because after all risk management in trading is the best way in this trade if we want to feel secure in the trade and avoid the risk of large

Good article indeed. We should look at our risks and lower them at all possible. I do this by only trading with the best pairs that have high volumes and in demand all the time. I also trade with low spread and also only in 2 market overlap sessions that will yield more demands and I only trade during open market hours like London and NYC, as these two are very powerful. 

[surya77]

if we can uunderstanding money management and risk have, we can easily to know how to minimalize a risk have and increase you profit run percentage. risk managemnt is important point in here.

[myregister]

if we can uunderstanding money management and risk have, we can easily to know how to minimalize a risk have and increase you profit run percentage. risk managemnt is important point in here.

Extremely true, with understanding the risk management , All risks that we face can be diminished even though basically the risks that exist i Foreing exhange is large. However, Risk management also gives us the experience to control emotions very well and make us more discipline