Forex Trading Guide

How to Manage Risk in Trading FOREX

When it comes to trading FOREX. Once you have the facts it is decision time. You can choose to take no action or seek to reduce the exposures. Or decide to hedge them in whole or in part. The unforgivable mistakes are to fail to consider the risks. Or fail to act on any decisions.

Risk Management

The risk management of trading FOREX is important. Above all, it calls for honesty. Too often traders are criticized for decisions. Which, at the time, were in perceived appetite for risk. Though setting down effective guidelines is often not easy. And the range of exposures for even a simple transaction can be extensive.

While losses are likely to be quantitative. The potentially infinite number of risk combinations means that the skills needed to make good decisions are usually qualitative. Even a computer (Expert Adviser trading Robot) programmed to consider all possible risks. Is required to be told how much exposure is acceptable.

Any program or automatic trading robot is only as good as the parameters. And be programmed by an experienced programmer with FOREX market understanding.

Expect the unexpected

But what about the improbable. The completely unexpected or the never-seen-before? Effective risk management requires thinking about the unthinkable. This in no way reduces the great value of the many sophisticated risk-management systems. The problems arise if people start to think of them. And the models they are based on. As being safe or failproof.

Caution and responsibility

Be cautious not to open trades until the exposure is known. To be in the FOREX business you must make decisions involving risk. However the sophisticated the tools at your disposal. You can never hope to provide for every contingency. But unpleasant surprises should be kept to a minimum.

What to consider

Ask yourself this:

1: Can your trading risks be identified. What are they and do you clearly understand them? Especially if you have several open trades all at once?

2: Do you grade your business in a structured way?

3: Are you aware of the maximum potential liability of each exposure?

4: Do you base your decision-making on reliable and up to date information?

5: Are the risks big in relation to the turnover of your business. And how could it impact your profits and trading account balance?

6: Over what time periods are the risks in effect?

7: Are your trading exposures to risk one-off or recurring?

8: Do you know enough about the ways in which your exposures can be reduced, or hedged. And would it be worth it? Including the potential loss of any positive profit?

9: Have your trading and risk-management functions. Or decisions… been adequately separated?

Where to place Stop Loss (SL)

An important part of a trader’s strategy in FOREX is using Stop Loss (SL). On all open positions. Preferably, the SL should be set before placing a market order. However, it can also be done by adjusting the existing open position(s).

A trader needs to exit (close) a trade. Either when he is uncertain about the trade. Or if it is a trade that’s gone bad. Or simply when we no longer want to hold onto that particular position. The question that arises is: WHY do we want to get out of that trade?

Exiting a bad trade is important

There can be 2 reasons for stepping out of a trade. If the market tells us that. Or our own inherent View or Directional Assessments itself was wrong. And maybe we exit a trade (even if we still believe in our basic Bullish or Bearish analysis or instinct). Due to the belief, we can open another position at a better level than the previous one! Remember this well.

And don’t be thickheaded and hold on to a bad trade draining your account! Close the bad trade before it gets much worse. You can then rethink and reanalyze the market and find a new, better trade position to open.

Your focus needs to be on setting a meaningful SL (Stop Loss). Not too close to the entry point to get activated soon after entering the position. Avoiding the chance of market reversing back to the original direction. Nor do you want so far away from the entry point. To avoid time or space left for follow up action.

A Plan and Strategy

What’s important is to have a Trading Plan or Strategy. And to choose our Entry carefully than we tend to do. In accordance with that plan. Follow through action required we come back to the reasons for wanting to stop out.

When your directional reading has been proved wrong. You should look to enter into a trade in the opposite direction. his is called SAR; Stop-and-Reverse (SAR). Please note that it is NOT necessary to SAR. At the same instance and level or too often / all the time.

In case you are an intra-week (or longer), FOREX trader. You can enter into a reverse trade after closing the original trade. This gives you time to rethink your strategy.

Risk and Reward

As a trader, you should NEVER be trading at all. If risk/reward analysis is not at the top of your highest priority!

If a trader has no idea of the potential profit return on any initiated trade. Relative to the initial risk of taking the trade in the first place at all. Long-Term profitability may not look so good.

Obviously, and for all traders. The best scenario would be to minimize the first. And maximize the second.

Technical Analysis and Indicators

But how can this be done on the potential reward? In any type of investment and the risk, you might be taking on? The answer is Technical analysis. Analyzing charts can help traders evaluate both risk and reward.

Technical indicators used on your charts. Will give you the simplest kind of insight to a currency’s performance. Simply by placing your support and resistance. And by looking at the past performance of the currency. You can obtain a past record of its closing price over time.

When all of the elements are in place and ready for analysis. You can calculate your pips difference and verify. Depending on the market trend, if you will make more profits or losses. And if after all, it is even worth opening the position. For example, if the market is in a Bullish situation.

A higher pips difference between your buy-stop order is required. Just as your resistance price than between your support price. And your buy-stop order. So that your reward will be maximized and your risk will be minimized.

In each case, the upside (bullish) or downside (bearish), the tools of technical analysis will tell you important things about risk and reward. Don’t trade without them.