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Forex Risk Management | How much should you risk on currency trading?

Forex Risk Management

Forex Risk Management System – How To Stay In The Game

Forex Risk management is something that you will heard from every Forex coaches around the world. But all of them will tell you the some textbook words and you wont find it much beneficial for your trading journey. In this article, we would like to see the matter from a completely different view point and highlight some of the core Forex risk management factors.

Forex Risk Management

As a Forex trader, you are the boss – all the control is at your fingertips. With this kind of power you can either crash the plane or fly safely above the clouds. Unfortunately, most traders will result in the plane crash. Silly, obvious they make errors and hit outside the bargaining game, sometimes forever.

forex-risk-managment

No matter how sure are you about a situation, there is always going to be the chance that your predictions are wrong.

Traders are too focused on “the great victory” equity risking too much currency trading. Traders will neglect the change in risk management in the hope of achieving financial freedom in a play.

Successful traders know that there are no guarantees in trading. That is a fundamental principle that we as traders mentality prepared to build our business around.

Forex Risk management should be part of your overall risk management plan. There is no need for this to be difficult or complicated. There are some basic ideas that will give you a better idea of how to negotiate with security, higher levels of confidence. So, how much you’re risking vs how much you should be risking in Forex trading?

In this article, I will compare some of the management strategies common risks that are preached repeatedly in the industry – talk about them in more detail, and simplify each one so you can determine which is a good fit for you.

Do not place trades without a Stop Loss

Before go any further, I just wanted to stop in front of the subject of stop loss. I know it sounds like a broken record … but traders are still seen today not to have a stop loss and get absolutely screwed to it. I can not stress enough how important it is to always set a stop loss order with your initial trade. You simply can not manage your risk without a stop loss.

When a trader triggers a position without stop, then the account is exposed to risk of 100%. Think about the remote possibility of a failure of a power outage or power equipment! What if a central bank intervenes at the same time, the market moves 1000 pips against you? You are about to suffer huge unnecessary losses.

Always remember this: “No Stop Loss = No Money Management”

Do you know how many traders I know who lost a large part of their capital when the Bank of Japan intervened? Do yourself a favor, if you are not putting stops it is time to clean your risk management change and start protecting. Placing trades without stop protection is one of the biggest mistakes of novice Forex traders.

Forex risk management dynamics

One of the most popular models of Forex risk management, greatly promoted in the community currency is the “2% rule’. Before placing a trade, to calculate the size of their position with their sizing stop loss risk 2% of its available capital.

The idea behind this system is to limit losses in periods drain down, and to gradually increase your risk as your account grows. It works like this; if you are in the middle of a losing streak currency, your account will obviously be in the negative. Therefore, when you risk 2% of your remaining capital available, you will be risking less money than his first initial trade.

The farther into the draw down you have, the less you risk per trade. This is effective in slowing the disintegration of capital when the markets are not responding well to your system. It sounds good so far, right?.

The only problem with this model is that it must work harder to recoup their losses. When a risk / reward money management system fails, like you have an account with 100 USD and you keep taking 2% risk in each your trade. So it seems that you have lost 10%. So it equals to 10 USD. But actually it’s not 10 USD, it’s less than that. Because at first trade you risk 2 USD and your new equity is 98 USD so in the next trade you are risking 1.9 USD not 2 USD.

One the other hand it is difficult to recover the loss, because to recover 50% loss you have to make 100% profit. For example, you have made 50% loss to you account and now your new account balance is 50 USD. So to move the equity to 100 USD from 50 USD you need to make 100% profit.

hard-to-recover

Let me elaborate with an example …

Let’s say you start with an account of $ 5,000. A couple of trades is lost and you’re down $ 1000. The account was sitting at $ 4,000.

@2% risk, now would be risking $80, Instead of the $100 risk taken @ $5000

3 risk / reward, their business benefits will be $ 240 instead of $ 300, so it’s a little harder to recover losses: If a 1 is used.

Take a look at the table below. Shows you go into tie for the harder it is to recover their losses.

example

Let me elaborate with an example …

Let’s say you start with an account of $ 5,000. a couple of trades is lost and you’re down $ 1000. The account was sitting at $ 4,000.

@2% risk, now would be risking $ 80, instead of the risk taken $ 100 @ $ 5000

3 risk / reward, your trading profit target  will also be $ 240 instead of $ 300, so it’s a little harder to recover losses: If a 1 is used.

Take a look at the table below. Shows you go into tie for the harder it is to recover their losses.

Screenshot_1

FOREX RISK MANAGEMENT : LINEAR Risks

Fixed risk model is a very simple, simplified procedure for exchange risk management approach.

If you take a fixed risk, then you feel comfortable risking per trade, and they continue to endanger this amount in each transaction, regardless of whether your account is in a gain or loss, the amount of risk is selected and predefined.

As the name suggests, the fixed risk model is more linear in nature.

You do not have to work harder to recover from losses. When it combined with the rule 1: 3 risk / reward – you can keep ahead, although most of its trades are losses.

If you risk $ 200 per trade, then you are aiming for a return of $ 600. That means that if you lose 3 trades in a row (- $ 600) need only 1 winner to return to breakeven ($ 200 x 1: 3 risk reward 600 = $ +).

So essentially, you just need to win 25% of your trading to remain at breakeven. The higher you aim your reward ratio, less trading is required to win to move on.

This approach may not be for everyone, especially the most conservative traders. The  linear risk model does not slow down during periods of draw down, or benefit from an account in the positive.

My approach to Forex risk management

We’ve looked at the pros and cons of each model of common risk management. One is designed to limit the risk in the draw down, and strengthen the game when the account is doing well. The other has a more linear and non-commercial risk approach based on the statement fits – but easier to recover from losses.

Personally I like to mix a little of both together. To determine my business risk, I will use an initial estimate % from dynamic money management model. Not necessarily 2%, but maybe 3 or 4%. It comes down to how much you are risking comfortable, and the degree of confidence that is your trade.

Once calculate an initial business  dynamic money risk management model, I plug contained in the linear model. For example; with an account of $ 5,000 you might decide initially risking 3%, which would be $ 150. Then switch to linear model money management and risk $ 150 per trade regardless of whether the account is up or down.

If the count of 10 suffers losses in a row, then you can recalculate the risk adjustment using the dynamic model, and then reconnect that linear model.

So 10 losses would be – $ 1500, leaving the account with $ 3,500.

3% of $ 3500 is $ 105.

Therefore $ 105 will be my new trading risk.

The same applies to account gains. If you come to say a gain of 25% account, make the same settings.

+ 25% x $ 5,000 = $ 6.250.

The new trading risk will be 0.03 x $ 6,250 = $ 187.50

By using a hybrid to change risk management approach, you can get the best of both worlds.

Take a look at the EUR/GBP chart below…

eurgbp

If each signal took action only decent price in this table with a $ 200 risk on every trade; I would have suffered two defeats, I managed a full 1: 3 return, and have an open trade that is currently floating in 1: 1, but appears to be well on the way to hitting to 1: 3. If the open trade hits its target, then a floating profit of $ 800 + will be achieved.

This is a classic example of how you can make money even with the failure rate of 50% – All the magic is in money management.

The bottom line: Forex Risk Management

At the end of the day, it may be that the trader should only risk what he feels comfortable. As long as you think with odds and have a plan to protect yourself, you are already a step ahead of many other Forex traders. If a trade is placed, break a sweat and are having trouble falling asleep at night, you are risking too much. Before performing a trade, ensure that the trade setup is high quality and is in line with its risk management plan for change.

Defining the risk of currency trading is only a small part of a good management plan of sound money. Some systems offer important money management process which is described in numerous articles in our site. All our money management systems are positively oriented, which means they are designed to return more than your risk.

To have a better understanding of forex risk management, go through this article of investopedia.

For more information about our Forex money management plans, or any of our strategies of price action, please stop by and check out the site’s Forex School section.

About the author

Zahid Hossain

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