The Basics of Managing Risk
Forex traders can have the best systems in place, but still fail due to their lack of appropriately managing risk. Risk management can be said to be a combination of different ideas and strategies to control the risks of trading. Losses are sometimes unavoidable in the forex market, but it is essential to control them where possible. Orbex even looked into the specifics of managing risk on a friday just last week so, today we will explore the basics of risk management.
Knowing the Market
The first thing step is to know the odds of a successful trade in and out. For this, traders should know the concepts of fundamental and technical analysis. Understanding the dynamics of the market and knowing price trends are important for making informed decisions.
Controlling Losses or Stop Loss
It is quite a feat to figure out where to set one’s stop loss, so that it reasonably limits the risk and does not take the trader out of a position too soon. But once it has been established, it is necessary to stick to it, and not fall into the trap of moving the stop losses farther and farther out. Some traders also keep mental stops for this, to determine how much pressure or drawdown they can take for the trade.
In the forex markets, liquidity means that there is a sufficient number of buyers and sellers trading at the current prices to efficiently make one’s trade. Major currencies are mostly liquid. This liquidity is not available to all brokers and is not the same for all currency pairs. Broker liquidity affects traders. Well-known and well-capitalized brokers are usually devoid of liquidity risk.
Leverage or Lot Size
Leverage is a big risk magnifier. The idea of using huge sums of the broker’s money rather than your own is very inviting. One of the biggest benefits of the forex markets is the availability of this high leverage, which, of course, works in two ways. Returns could either be doubled or accounts could get wiped out very quickly. Hence, the best rule is to be as conservative as possible. Smaller lot sizes encourage more flexibility and help keep emotions out of the game when managing risk.
Tracking Risk Exposure
The correlation between forex trades are a good way of measuring and managing risk exposure. The correlation shows how changes in a currency affect another currency. Correlated currencies usually follow common trends. Risk is always driven by margin, so trading in pairs that don’t have significant positive or negative correlations is a good idea. Currency correlations are more important when it comes to forex scalping. When one must maximize gains in a short period of time, it is important not to trap the margins in the opposite correlated currencies.
It is a known fact that of all the risks associated with a trade, the one that is most difficult to manage is the bad habit patterns of the trader. Some risk is essential for good returns, and a disciplined approach helps with that.