Topic 8: How to Manage Risk in Forex Trading

Last updated on October 11th, 2022 at 12:49 am

A trader can manage risk in forex trading by using a proper risk to reward ratio and creating a good trading plan. Poor risk management is one of the many factors that hinder the success of most Forex traders. This article explains tips you need to know to help you manage risk in Forex trading.

Don’t focus on making money; focus on protecting what you have.

Paul Tudor Jones

Best Tips to Help You Manage Risk in Forex Trading

1. Develop a Trading Plan
2. Set realistic goals
3. Use a Stop Loss and Take Profit
4. Avoid Currency pairs that are correlating
5. Always control your emotions
6. Set your Leverage and leave it
7. Do not risk more money than you can afford to lose
8. Start using any trading strategy on a Demo account
9. Embrace a good Risk to Reward ratio
10. Prepare for the worst
11. Trade With a reputable Broker
12. Start with a small account balance

1. Develop a Trading Plan

Trading without a trading plan leads to overtrading, confusion, and emotional stress. Unfortunately, traders who have a trading plan do not confirm the plan when opening trades. This makes them close most of their trades in losses even though they may be lucky in a few trades.

4 Things a Trading Plan Must Contain

• A predefined entry point.
• Exit point.
• Risk to reward ratio.
• Daily maximum drawdown.

2. Set realistic targets

Setting realistic targets enables traders to minimize drawdown and maximize profits. If you can afford a bigger account, target a 5% monthly return. A realistic target is part of proper risk management. It will ensure you make consistent profits.

3. Use a Stop Loss and Take Profit

Sometimes the Forex market becomes very volatile due to unnatural events or economic news releases. When there is sudden volatility in Forex, three things may happen:

• The price may move towards your take profit, but before it hits the take profit level, it reverses and wipes your account.
• The price may move towards your take profit and close your trade in profit.
• The market may instantly move against your forecasted direction and wipe the account.

That said, it is essential tosetstop loss and take profit to prevent the account from being blown and secure profits.

4. Avoid Trading Correlating Currency Pairs

Correlating currency pairs move simultaneously in either direction, upward or downward. If two currency pairs move down or up simultaneously, that is a positive currency correlation. When one moves up while the other moves down at the same, that is a negative correlation.

To increase your chances of success as a beginner in Forex trading, avoid trading correlating currency pairs. Pick noncorrelating pairs and master how to play around withlot sizes.

5. Learn to Control Your Emotions

Every trader’s goal is to ensure that their profit exceeds the loss at the end of a trading period. Do not be carried away by your emotions when you are in a losing trade and when your trades are in exceptional profits.

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6. Set Your Leverage and Forget About It

Leverage increases a Forex trader’s chances of gaining more profits. Likewise, it increases the chances of incurring more losses. The lower the Leverage, the better.

In Kenya, the maximum allowable Leverage is 1:400. Which is the Capital Markets Authority(CMA) recommendation.

7. Do Not Risk More Money Than You Can Afford to Lose

You can lose all your investment in Forex trading because the business carries high risk. Most often, inexperienced traders deposit the only money they have into their trading accounts so they can double it. Do not do that. Let the money meant for other expenses be and look for trading capital.

8. Test a New Trading Strategy on a Demo Account

Once you find a trading strategy that you like, backtest and forward test it thoroughly on a demo account until you are confident with the system.

Deposit a little capital for practice on a live account. It should not be anything below $100.

Backtest a currency pair you plan to trade. Most often, beginners find the EURUSDpair easy to trade.

9. Use a Good Risk to Reward Ratio

A reasonable risk to reward ratio should give you a win rate of over 50%. Even if you close some trades in losses, you will likely record profits if you can maintain a win rate of over 50%.

For example, if you open ten trades in a month with a risk to reward ratio of 1 to 2 and half of the trades end up in losses, you will still close the month in profit.

10. You Must Prepare for the Worst

If you do the following, prepare yourself for emotional weakness:

• If you trade with an unreliable broker
• If you trade without a trading plan
• If you trade without setting stop losses
• If you trade correlating currency pairs when you are still a beginner
• If you risk more than you can afford to lose
• Suppose you keep trading even after recording a loss at the end of your trading season(monthly, for instance). You need to stop trading and find out what mistakes you are making.

11. Trade With a Reputable Broker

Take your time when selecting alegit forex broker. When researching a good broker, consider account type, spread, broker regulation, customer support, etc.

12. Start With a Small Account Balance

When you are done practising on a demo account, it’s advisable to test your emotions by starting to trade on a live account with small capital(at least $100).

Conclusion

If you can manage risk in forex trading correctly, you will minimize losses and maximize your profits in Forex trading. Good risk management skills also boost a trader’s confidence. See you in the following article.

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