With an average daily volume of $1.4 trillion, the forex market is larger than all the futures markets combined and managing forex trading risks is imperitive to success.
Once the closely held secret of banks and corporations, forex trading is now available to the public along with the same risks and rewards. More than any other market, the forex market can move against you quickly. The best way to manage your risks is to thoroughly understand how this unique market works and what drives it up and down. Your experience with other markets can help you understand but still, the foreign exchange market is difficult to predict.
The risks of forex trading are high as price can fluctuate for reasons that are out of our control and unforeseeable including shifts in political and economic policy. These unpredictable circumstances are what drives the value of these currencies up and down and changes their value in respect to other currencies. It is this very volatility that attracts investors. It’s imperative that you understand all of your buying and selling options so you (and your broker) can react to these currency fluctuations instantaneously.
Besides knowing about FX in general, another way to control your risk is to manage your trades without emotion. We know we should only trade with money we can afford to lose, but when we are losing (and winning) oftentimes we let our emotions get involved in our trading decisions. Doing so can increase your risks considerably so don’t let this happen!
Instead, determine a percentage you are willing to risk on each trade and stick with it. Some traders are willing to risk up to 3% or more on every trade. This may not seem like a lot to risk, but 3% of $100,000 is $3,000. When you have multiple trades open, it’s important to stay on top of the percentage that you have at risk because multiple losses can be devastating and one big loss can wipe out all of your other profits.
Most forex brokers provide the ability to set stop losses. You should determine your stop loss at the time when you enter a trade, and set the stop loss in the trading program. When your stop loss is reached, your trade will be automatically closed out, limiting your potential loss.
It is important to take the volatility of the market into account when determining your stop loss amount. If you set it too large, you could lose a significant amount of capital before the stop loss is triggered. If you set it too small, the random ups and downs in the market will mean that your position is being closed early, incurring additional transaction costs.
Another smart risk management strategy is to avoid holding positions in two currencies which tend to move together like the British Pound and the Euro. These currencies are correlated. The most common pairing of currencies is the US Dollar and the Euro. Since the British Pound and the Euro typically move in the same direction up or down, you should look to select a second pairing of the US Dollar with a currency other than the British Pound.
You should also avoid taking a long and short position in currencies which generally move in opposite directions. This is the same situation – you are taking on more risk than you need to.
And finally, leave the gambling urge to the casino crowd. If you’ve lost money on your previous few trades, don’t double-up your next trade in order to â€œrecoupâ€ your previous losses. Your odds of profiting on your next trade won’t increase as a result of your previous losses. The odds of winning remain 50-50 every time you trade.
Forex Trading Profit
It is often a good idea to lock in forex trading profits when a position is positive. There is nothing worse than a position getting very close to your take profit price then having the position turn negative. Break even stop losses can also be placed to make a profitable position completely risk free.
Dangers of Forex Trading
The foreign exchange market is exciting, fast, and has a huge profit potential. However, this type of trading is definitely not for everyone, so proceed with caution and make sure that you have a strategy in place to limit your losses. Failure to use proper risk management can result in huge losses. FX Risk Management is essential.