Forex Trading Techniques : What makes a trading methodology “good”?
Risk Management : I would like to continue the dialogue on ways to find the right trading strategy for Forex trading. Previously, I shared that for any Forex trading method to be considered, it must be a complete method (insert link to previous article).
Today, I want to add to that by talking about risk management. This is maybe the area where 95% of Forex traders screw up and lose cash. Managing risk is about reducing your losses AND about protecting trade capital by employing specific strategies to accomplish each of these simultaneously.
What do I mean by that and why is it important?
First, most Forex traders make simple trading mistakes: they take too large of a position and expose themselves to serious and steep losses should the markets move against them. 2nd , they fail to guard their Complete account by permitting ONE trade to put their full account balance at risk.
Here’s a fast and maybe acute example:
Suppose a foreign exchange trader has a $10,000 account balance. The currency exchange trader takes a five standard lot currency exchange trade on the EUR/USD pair. The forex trader now has at least $5,000 ‘margin’ at risk (or 50% or more of the forex trader’s account balance).
For every 1 point that this forex trade moves against the forex trader, the trader loses 1/2% of the total account balance. Find out more see my Forex Income Engine 2 Review. At first peek, that might not seem to be a steep loss. However, should the Forex trade move a total of fifty pips against the Forex trader , and the trader afterwards exits the position, the currency exchange trader ’s total loss would be an INCREDIBLE $2,500! ( 25% of the trader ’s account balance ). This is poor risk management and it frequently leads to complete wipeouts of Forex trading accounts.
How did we calculate that loss? 1 pip for the EUR/USD pair is equal to $10 (on a standard lot trade). A 50 pip loss equals a loss of $500 ; and remember our example currency exchange trader had traded five standard lots — for a gigantic loss of $2,500!
Instead, any trading system should teach you very particular rules for incorporating cash management and risk management into each currency exchange trade you take. For details read this Forex Income Engine 2.
Money Management should involve the distribution of a currency exchange account among the assorted trades a foreign exchange trader takes. As an example, forex traders should never trade their complete account on a single trade, and should barely have more than some open positions. By using multiple positions, the currency exchange trader distributes the chance among each one of the foreign exchange trades they have taken.
Risk management should involve the maximum risk in any SINGLE Forex trade, and should limit the impact of a losing Forex trade on the trader ’s account balance.
Here are 2 fast examples:
Money Management : A unproven foreign exchange trader takes four separate one lot trades on 4 separate pairs. Presuming here that every one of the pairs have a pip cost of $10 on the standard lot, then the whole amount of the account being margined across all 4 trades is about 40% ( it could be higher relying on the pairs traded. With proper stop loss management, however, in conjunction with risk management, it is UNLIKELY that the forex trader would incur a complete 40% loss.
Carrying forward to risk management: In each of the theoretical forex trades above, the forex trader risks no more than 2% of the trader’s total account balance on each forex trade. That suggests a maximum loss of $200 per foreign exchange pair traded if ALL FOUR trades are stopped out. Total loss in this situation would be $800 — a way more recoverable eventuality than the $2500 in the 1st currency exchange trade example.
Furthermore, Risk Management has the capacity to make loss recovery less complicated. As an example, in the 1st case, where the Forex trader lost $2500, the trader would need a virtually 250% gain on their next trade to recover the lost value on the 1st trade.
In the second example the foreign exchange trader would need only an 8% gain.
A second part of Risk Management not generally debated in poor trading strategies is protecting gains. Though this begins as a discussion on Exit Strategy rules, it is also an element of risk management. Once a foreign exchange trade turns profitable, it is urgent the foreign exchange trader manage the gains with smart stop loss management. The worst thing a forex trader can do is allow a profitable position to reverse and become a losing position. Therefore , handling risk extends to the protection of gains on a currency exchange trade, just as it does shielding against deep losses on a currency exchange trade.
Therefore, in considering any trading system for use in your Forex trading, you have to make sure that risk management is not just debated, but obviously explained together with the use of the trading methodology. If risk management isn’t present, confusing, or not explicit to the trading strategy, you have to avoid using that trading method. For details read this Forex Income Engine 2.0 Review.
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