The realm of forex trading is very rewarding for those who learn to deal with the risk. In trading, there is no reward without risk and when you step into the currency market for the potential gains, you must be prepared to embrace the potential losses as well. Because losses are often unavoidable and the only way to minimise these losses is risk management. Automated tools like trading calculators can assist you by quickly calculating accurate values for the trades and by doing so, you can limit the risk per trade.
In this article, you will get to learn the top 4 risk management techniques that you can apply as a novice trader in the dynamic forex market.
1. Always Place Stop-Loss & Take-Profit Orders
Stop loss and take profit orders are two of the most powerful tools for risk management in trading and using these tools is also very easy. A stop-loss order is placed at a price level where you realise the loss from a trade. This order is placed when you enter the trade and when the price of the currency pairs moves to the specified price point, the trade will be automatically closed at a loss. By using stop-loss orders, you can cut the losses early as you won’t be losing anything more than what you have prepared to lose.
Losses are not just about the market moving against you but they can also be about failing to secure the profits before a sudden reversal turns your winning trade into a losing trade. In that case, a take-profit order can save you as it works like an automated exit for a trade that you have won. You just place the take profit at a price level where you get to make enough profit and once the price moves to this point, the trade will be closed at a profit. With a take-profit order, you can minimise the risk of losing your hard-earned profits.
There is another type of stop loss that you can place for locking your profits in a flexible manner. The regular stop loss is a fixed stop loss and you need to adjust it manually if you see any changes in the market situation. But there is another type of stop loss which can move on its own and help you lock the earned profits even if the market starts moving against you afterwards. I am talking about trailing stop loss orders and they can be used when you want to preserve the gains of a trade.
2. Diversification & Hedging
Diversification is a standard technique for risk management and when it comes to forex trading, diversification can be done by trading with different currency pairs after considering their correlation or following two distinct strategies based on the market situation. There are many things that you can do to mitigate the risk by diversification in the forex market. For those who are planning to generate an income by investing in Managed Forex accounts, diversification is easier as they can allocate the funds to different account managers to limit the risk.
The most popular managed account services in the forex market are MAM and PAMM accounts. In PAMM accounts, the profits and losses are shared among the investors based on a percentage basis as the percentage of funds that they have allocated to a fund manager is considered. In the case of MAM accounts, you can set your own rules for risk management and the professional trader can only handle the funds based on the conditions that you have set. The risk can be minimised as experienced traders manage your trading activities on your behalf.
Another powerful technique that you can apply in forex trading is hedging. In hedging, you pick a currency pair and open two trade positions in the opposite direction. For instance, you will be opening both long and short positions in the EUR/USD pair and by managing the trade size, you can offset the risk as you won’t lose much even if the market becomes unfavourable for the first trade that you have entered. Hedging is a popular technique, but not every trading platform supports it. MT5 is a platform that supports hedging, so you can trade on this platform and manage your risk by creating a hedge especially when the market is highly volatile.
3. Follow The 1% Rule Of Trading
The traditional rule for risk management in trading is to never risk more than 2% of your account balance but limiting the risk per trade to 1% can be even more effective. 2% is the maximum percentage of trading capital that you can risk for a trade but when you bring it down to 1%, the potential losses can be greatly reduced and the account drawdown will also be within the limit. This approach is perfect for a novice trader who is not ready to take big risks in the initial phase of their trading journey.
In order to find the ideal risk percentage for your trades, you can simply open a demo account and place trades with virtual funds. By demo trading, you will get to learn and experience the impact of risk without losing any real money in the process. Another thing to consider while setting the risk percentage for your trades is the size of your trading accounts. Those who have smaller-sized accounts can afford to risk more than 1% on a single trade as the amount that you risk will still be small.
But for those who have bigger-sized accounts with a huge amount of capital, the risk will be higher even with 2%. Thus, the 1% rule works better for them as the trade size will already be sufficient with only 1% of capital being used. But while applying the 1% rule, you should also consider the amount of leverage that you are using as leverage also plays a key role in risk exposure.
4. Always Consider Your Risk Tolerance
Every trader has a different risk appetite. Some of us can handle high risk for a higher potential reward but some of us have a low risk tolerance and want to play it safe. Hence, you need to assess your own risk tolerance and make all trading decisions after considering the level of risk that you can afford to take at the moment. For instance, exotic pairs are very volatile and risky in nature and thus traders with a low risk tolerance should never trade with these pairs.
On the other hand, major pairs like EUR/USD are considered to be the safe haven for traders as they are very liquid and more stable in comparison. Thus, those who want to trade with minimal risk should stick to major pairs only. Major pairs are especially ideal for beginners as they are easy to trade with. Those who can afford to take moderate levels of risk can also trade minor or cross pairs as they are more volatile than major pairs but also highly liquid.
Final Words
With that, we have discussed the top 4 risk management techniques that you can apply as a new forex trader. Risk management is a key component for trading success and those who master the art of risk management can surely make consistent profits in the long run.
