Forex trading risk guides: A must-read for Beginners
Risk management is the most significant part of your trading plan. If your plan is to succeed and last in the forex market, you must develop a good risk management strategy. Before you open a live trading account with a forex broker, you must learn ways of managing your risk as a forex trader. Without workable risk management system, it’ll be hard for you to make money in the forex market.
Contents
- 1 What is forex trading Risk Management?
- 2 Risk Planning and your risk forex trading Risk Reward Ratio
- 3 Trading Risk Reward Ratio
- 4 How you can estimate the risk reward ratio?
- 5 Position Sizing
- 6 Fixed Fractional Money Management technique
- 7 Fixed Ratio Money Management Strategy
- 8 Why Good Risk Management is essential?
What is forex trading Risk Management?
Forex trading risk management is the process utilized by traders to minimize or safeguard their personal trading account from the peril of losing their entire account balance.
Forex risk can be defined as the possibility of losing out on a trade. If you learn how to manage your forex trading risk, you have a better chance of succeeding as a forex trader.
Essentially, risk forex trading management is generating a system that helps you to manage your risk of exposure when trading in the forex market.
Managing your risk of forex trading is like building a foundation for your house. The stronger the foundation, the more sturdy and long-lasting the house would be.
The same way the foundation of your house determines whether the house will stand the test of time, your risk management system determines whether you will last as a trader or not.
Your forex risk management system determines if your trading plan will succeed. Forex risk management system can thus be divided into three:
- Risk Planning
- Trading Risk Reward ratio
- Position Sizing
We will explain below how you can make use of these risk measurement yardsticks to develop great risk reward ratios for your trades.
Risk Planning and your risk forex trading Risk Reward Ratio
Planning your risk will assist you to be consistent with the risk you take while trading forex. To overcome the temptation of consistently trading, you need to plan your risk exposure from the first day you start to trade.
To help you plan for your risk management, you ought to answer this question: What is the maximum amount you are willing to risk for every trade. The recommendation is never to risk more than 2 percent on any specific trade. The benefit of the 2 percent risk rule is to help you take more trades at any specific time.
Planning your risk will assist you to better control the psychological aspect of trade because it let you know beforehand the amount of profit to make if a trade moves in your favor and what your loss would be if your trade fails.
Trading Risk Reward Ratio
The trading risk reward ratio merely determines the possible loss against the possible gain generated from every trade.
How you can estimate the risk reward ratio?
The risk is merely means the price distance between your entry and your stop loss. The reward merely means the price distance between your entry and your take profit. Thus, to estimate the risk reward ratio you merely require three factors:
- Entry Price
- Stop Loss
- Take Profit
To determine the risk to reward ratio, you merely require dividing the prospective “Total Risk” to the prospective “Total Reward:”
Position Sizing
Position sizing determines the how large each trade you make would be. Do you want to choose at random or always make it 5 lots or 1 lot?
There are many ways you can estimate the position size. Your final choice is up to you.
To estimate position sizing you need three parameters:
- Account size.
- The percentage of money in your account you can comfortably risk
- Stop Loss.
The standard formula for estimating your position size is:
Position size equals to Account size multiplied by percentage Risk per trade divided by Stop Loss.
Two commonly used management techniques are:
- Fixed Fractional Money Management technique
- Fixed Ratio Money Management technique
Fixed Fractional Money Management technique
With fixed fractional money management technique, you only risk a percentage of your trading account for every trade you make. This is commonly 2 percent for every trader order you make. The benefit of fixed fractional strategy is that the position size increase with account increase.
Fixed Ratio Money Management Strategy
The fixed ratio technique utilizes a specific position size that rises and falls with the amount you have in your account.
Why Good Risk Management is essential?
Having a trading risk management strategy is perhaps the most significant part of your trading due to the fact that it will guarantee the long-term continued existence in the market irrespective the difficulties you meet as a trader.
