Managing Forex Trading Risks.
Managing risk is the most important part of investing, whether you are trading Forex, stocks or any derivative market. Novice traders are too focused on their potential profit outcome rather than their potential loss. Here are some tips to manage your Forex trading risk.
Limit your drawdown. Use a stop loss. A stop loss is a price you are going to exit a trade for a loss. Every online trading platform will allow you to place a stop loss at a predetermined price and if that price is reached then your automatic stop loss will take you out of the trade and limit any further drawdown. If you enter a trade and fail to enter a stop loss thinking you will exit manually if the market moves against you, you can never manage your risk to a % or $ figure over a series of trades. Entering trades without predetermined stop loss levels put in place usually leads to an emotional decision to exit rather than a logical one. Some of the biggest losers in financial markets trade without stop losses. Many of their common errors are these…
“It’s going to go back up so I may as well stay in the trade.” This is a classic mistake novice traders make, they cut profits early when they are in winning positions but they will let losing trades run thinking the market will at some point in the future return them into profit. What inevitably happens is the market continues to move against them to the point they cannot handle their loss emotionally and they bail out of the trade for a substantial loss.
“I will just buy more so I can average my losing position.” Averaging into trades and buying more is a disaster waiting to happen. Often novice traders will buy more when they are in a losing position thinking that the market only needs to retrace less of a distance to get them back to square. What they don’t account for is the market could continue to move against them and often does, building the size of their loss at every tick. Ultimately at some point, they run out of money trying to buy more or they generally explode emotionally and they bail out of the trade. Never average into a losing position it is financial suicide.
“Price is getting close to my stop loss, I will just move it away a little bit as I think the price will go back up.” This is a sure fire way to increase the size of an already losing position, as the first time you move the stop loss likely won’t be the last time. Emotion and not logic will take over and the novice trader won’t just move the stop loss once, they will continue to move it further and further away until at some point they explode mentally and they bail out of the trade. If you have a stop loss in place and price gets close to it, just remind yourself why you have the stop loss in the first place. It is to limit your loss.
“I just got taken out at my stop loss, now it’s going back the other way, I’m buying back in.” This thought process is being driving by emotion and not logic. Just because your stop loss has been hit and the market is moving back higher doesn’t mean that price will continue higher. A lot of money is lost by novice traders jumping back into trades after their stop-loss has been hit. Their pride has just been dented, it doesn’t feel nice to be a loser and most novice traders take losing trades personally rather than looking at losing trades as the overhead to running your business.
Never be afraid of your stop loss being hit. Trading success is not about how many times you get it right or wrong. Trading success is about successful risk management and how much you make when you are right and how little you lose when you are wrong. Let me give you an example of what I mean. Assume I take 20 trades in a month. I get 9 of them correct and they hit my profit target, meaning I am less than 50% successful and I got more losing trades (11) than winning trades. If I told you I only make money less than 50% of the time you’d naturally think I am a losing trader. But how about if on the 9 winning trades I make $200 and the 11 losing trades I only lost $100. This is a simple 1:2 risk reward scenario and you would make $600 being right less than 50% of the time in this example. Trading success is a simple numbers game and managing risk and using a stop loss is critical to your success. Therefore no trader should be afraid of having a stop loss hit, in fact having losing trades is part of the cost of doing business as a trader, it’s the overhead to running a successful investment business. Just like a corner store has overheads it must look after, a trader must manage their risk and therefore must embrace and be thankful for when their stop loss is triggered.
How much should you risk? As a general rule of thumb, no more than 2% of the trading account size should be at risk on any given trade. For example, if your trading account size was $10,000 then $200 is the maximum amount of money that should be at risk on that one trade. Yes, 2%! Here at LTG GoldRock, we provide every client with a risk calculator. They simply enter the % risk they wish to take on the trade, the number of ticks to the stop loss and the risk calculator will tell them exactly what volume to trade to ensure they do not risk more than the predetermined % risk. If they prefer to use a fixed cash risk they can use the same risk calculator to work this out. It takes less than 1 minute to work out their volume to trade to ensure they stay within their risk limit and execute the stop loss at the right price.
When should I move my stop loss? The most common question I get asked by traders is when should I move my stop loss to break even when a trade goes in my favour? The answer to this question is simple but yet most traders can’t seem to execute what I am about to tell you. Moving a stop loss to break even may seem like a logical thing to do when the price starts to go in your favour, or trailing a stop loss a certain distance behind price may also seem like the right thing to do. But in reality, moving a stop loss to break even or trailing a stop loss behind price as it moves in your favour usually ends up limiting your profits rather than protecting them. Traders move stop losses on average far too often and over time would be far better off never moving a stop loss. Trying to guess when is the right time to move a stop loss always results in traders never having a specific approach to doing so. They are simply guessing when they should reduce their risk which seems logical but in reality provided their risk v reward profiles are 1:2 or better I can virtually guarantee that never moving a stop loss once in a trade would result in higher profit achieved over time. The reason being is that on so many occasions the trader moves the stop loss to break even, price retraces and takes them out and then price reverses to the profit target without them being in the market. They think they’ve limited their risk and got out of the trade for $0 but in reality, they gave up vital profit in a business where understanding the numbers game is vital.
The simple secret to success using a stop loss.
It is highly unlikely you are going to find a system of trading that is going to be much better than 50/50 over hundreds of trades over a series of years. Over various market conditions, most professional trading systems will be about 50% to 60% successful at best. Sure they may be correct 80% of the time for a given month or two but over years any trading system no matter what it is will likely average about 50/50. Therefore it is critical that on the 50% of the trades you are correct you make more than when you are incorrect. Again a simple numbers game! Toss a coin 10 times and it is possible that you will have 7 heads and 3 tails, or 7 tails and 3 heads, or even on the rare occasion 10 heads in a row. But flip a coin 1000 times and you will see the outcome over a series of flips is 50/50 the exact odds of a coin toss. Just average more on your winning trades than your losing trades and provided you are using a sound system of entry your probability of success is high. But you MUST limit your losses by using a stop loss.
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