Risk management is known as “money management” or simply “MM” among Forex traders. But MM is only part of risk management that covers a broader scope.
Forex Risk Management 101
- Educate yourself with Forex trading knowledge.
- Trade only currency pairs that you know about their fundamentals.
- Adhere to the trading plan with discipline.
- Don’t risk what you can’t afford to lose.
- Limit the use of leverage.
- Understand the risks before trading live.
- Set Stop-Loss trades in advance.
- Set Take Profit for realistic targets.
- Control your emotions while trading.
- Don’t FOMO (Fear Of Missing Out).
What is proper money management?
Every trade must adhere to a good risk/reward ratio.
For example, 50 pips Stop-Loss (SL) and 100 pips Take Profit (TP).
So the risk-reward ratio is 1:2, and the value of TP is two times the SL.
The higher the TP value, the better.
Let’s say in 10 trades, five times hit TP and five times hit SL.
TP 5 x 100 pips = 500 pips
SL 5 x 50 pips = 250pips
So, 500 – 250 = 250 pips profit
We are still profitable overall.
What is a drawdown?
The loss is often known as a drawdown (DD).
Let’s say you have a capital of $10,000 and have lost $5,000.
What percentage of your account did you lose?
50%. That is called a drawdown.
The higher the drawdown, the higher the profit required for breakeven again.
How much should you risk in Forex trading?
The simple answer is no more than 2% per trade.
Why?
See below:
What happens if you continue to lose (losing streak) until the 10th trade?
With a 2% risk per trade, your account has lost 17%. There is still a substantial balance of $8,337.48.
With a 10% risk per trade, your account has lost 61%. The remaining balance is only $3,874.20.
It is hard to recover if you have lost 61% of your capital.
You need to make 158% profit from the remaining balance to break even (BE).
Trading risk during news events
Trading during a news release is fascinating because market movements are usually large, with hundreds of pips in a short time.
Exciting, isn’t it?
But trading news is quite dangerous because many things are beyond our control.
Widening spread
For example, the spread for EUR/USD during the usual market hour is around 0.2-1.8 pips.
But it can go up to an extreme level (10-15 pips or more) during the news release!
Slippage
For example, you buy EUR/USD at 1.3400.
Chances are your trading order will be executed slowly, maybe around 1.3410.
Requote/Off Quote/Common Error
The situation that caused the trade cannot be executed.
Trading platform freeze/disconnect
It’s rare, but traders can’t do anything about it if it does happen.
Whipsaw
Price moves upside-down with high volatility.
Priced-in
It occurs when the price has moved hundreds of pips before the news release.
This situation is known as “priced-in” which means most traders can expect the news results.
So when the news comes out, the price only moves slightly and tends to make a reversal.