Forex Risk management Strategies
One of the greatest setbacks for forex traders, and investors are losing all their funds to the market, unfortunately, this seems to be the case almost all the time, as over 90% of traders and investors end up blowing their funds.
One of the major reasons for this is the fact that most of these people lack the risk management skills and strategies needed to carefully manage and grow their financial portfolios.
For some of these traders, after being asked why they ended up losing all their funds to the market, the complaint you hear doesn’t spring up only from their lack of the forex trading technical or fundamental skill, but also the fact that they never got good risk management tips that would have saved their portfolio.
It is no news that forex trading is fundamentally a risk. You go in, investing your funds and hoping that your trades and speculations are favorable. In the process, you will probably use advanced tools to predict price patterns and monitor financial news to stay updated on market movements.
Even if you mastered your trading strategy, another very important skill you need to learn in order to succeed as a forex trader is risk management skill. Unfortunately, risk management is something that many novices and beginner traders often neglect. Perhaps they think it is something so natural that they do not need to learn more about it.
They are probably thinking, I already know how to take care of my money, why would I need risk management tips? The fact is when it comes to trading with your money, with the aim of earning some good profit from it, risk management is a major skill you must learn. One of the most important secrets of profitable forex traders and investors is the fact that they have mastered the art of risk management, therefore they are able to properly minimize their losses and maximize their profits.
It is as simple as this, If you are not careful with your trading money, it’s inevitable that you will end up losing all your trading funds. Therefore, to keep this from happening, here are some simple risk management strategies to help reduce risks and improve profitable forex trading.
Forex Risk Management Strategies that Minimize Losses
Here are some Forex risk management strategies that can help minimize losses in trades and improve profitable Forex trading:
- Money management,
- Psychological management,
- Creating a trading plan and
- Keeping Proper Trade Records
- Understanding how to use your leverage
All these are very necessary keys needed in managing risk as a forex trader. In this article, we will be talking about three (3) of these risk management strategies, while we will discuss the rest in our next post. Now let’s look at how as a trader, you can employ these risk management skills and increase your chances of making progressive profits in your trades.
The first on our list of risk management strategies to use in improving profitable forex trading is the money management strategy.
The aim of every trader is to be profitable in their trades and make loads of money to live a better and fulfilling life and therefore, the motivation to burn through the nights and days carrying out research and understanding your market to better gain insights and ideas on how to explore your advantages, enabling you to make that money you desire at the end.
This is where a lot of beginner traders and novice traders get it wrong, they come into the trading industry for the money, but fail to understand that it takes time and effort to actually kick-start a profitable forex career.
A lot of traders see Forex Trading as a Get Rich Quick Scheme where they can just rush in, gets some months of training, with no knowledge of risk management, and instantly start making lots of money.
This is a very wrong notion, as I also emphasize to my students, ‘Forex Trading is an art, and its beauty is in the process, it takes a lot of time, work, and dedication to even start understanding the art while mastering the art of Forex trading is a journey which we all must enjoy.
Let’s examine it from this perspective, imagine forex trading to be like your business, of which I totally agree with that notion as it involves transactions, buying, and selling with the aim of making profit.
You won’t expect to open up your business with a Capital of $10,000 and then under a month or two make back your capital and also your profit.
Although there might be underlying differences between forex trading and your traditional businesses, the fact still remains that both of them involve transactions and also aims at making profit.
Some businesses take up to 2 to 3 years before they break even, then another 1 to 2 years before they start making profit which totals a minimum of 5 years, and as the business owner, you would have to be patient enough to attain or achieve this goal within this period.
In the case of Forex, it might not take as long as that and would even take a shorter time if you have access to materials and also experienced traders as mentors, it would still take some time before you can start making profit in forex trading.
In essence, the first thing you need to know when coming into forex trading is that you can’t start making loads of cash as soon as you start.
As it’s not a get-rich scheme, except you decide to use shortcuts such as signal channels and robots, but these have their serious downsides as you would spend lots of money to get any of these shortcuts and most importantly, you would not be in control of your trades rather you would be at the mercy of others; the Signal provider or the robot and in lots of cases I have seen this method lead to disastrous trades.
To have good money management skills, you must have a good and healthy mindset towards making money, know how to gradually grow your financial portfolio, and also make sure you are using Capital you can afford to leave for a long period of time without being overly bothered about how quickly you would double the capital and be able to withdraw the profit.
By so doing you enjoy the trading process more as you are not so eager to actually withdraw your proceeds.
Psychological management is one of the most important risk management strategies we can think of, as it has to do with you having the right mindset when trading, and being able to train yourself to overcome some of the overwhelming mental & emotional barriers or challenges most traders are likely to face when they start trading.
The 3 main contributors to emotional buying and selling in the market:
These three (3) emotions are most likely going to affect you as a trader if you don’t have the proper mindset when you start trading. We would be looking at how they can affect and influence your decision as a trader and also how to control these emotions.
As stated earlier, most traders tend to have the wrong mentality of making lots of money easily as soon as they kickstart their forex journey which causes more harm than good as they go along.
It is not wrong to be a very positive-minded trader but it is disastrous when you base your results on HOPE as it would affect your decision-making.
For example, let’s assume Chris, entered a BUY trade for EURUSD with $1000 equity in the trade and hopes to make some good profit with no target in mind, Chris also decided to set a STOP LOSS because he was told its necessary, after some hours he comes back to check the trade and finds out he is losing on the trade and has currently lost about $50 which is about 5% of his total equity.
Chris looks at the market and maybe decides to still hold on and shift the position of his STOP LOSS further instead of exiting the trade seeing that the trend of the market has been reversed or the pattern he saw entering the market is no longer in play, He still keeps his hope high.
Chris comes back to check the trade again in an hour’s time and sees the trade has further gone against his speculation his loss now running to $80 showing all indications of still going further against his speculation, he is reluctant to exit the market and still has some hope that the market would reverse in his favor after a while.
He, therefore, leaves the trade running till the next day removing His STOP LOSS position totally he comes back the next day to check only to see that he has incurred a loss of about $200 which is a whopping 20% of his whole equity, due to the fact that he refused to face the reality that his market speculation was not accurate at that time and he should have exited the trade earlier rather than hoping it would move in his direction.
You should also know that even when the trader puts a STOP LOSS as a precaution and even has a trading plan, many times the trader would go against this plan if they are unable to keep these emotions in check.
Therefore, while trading forex, emotions should be out of the picture and kept in check with strict rules and disciplinary measures.
This is also a very huge emotional challenge lots of traders face in their trading process and journey, as every individual is thrilled with making more money, and as we say in economics, ‘Man’s needs are insatiable.
As a trader it is very important to be very disciplined, this is a very important character every successful trader must imbibe before they make good success, it is not enough to just understand the market dynamics, it is also important to know how to navigate the market without involving emotions.
Greed is a trader’s killer because it keeps pushing the trader to take unreasonable trades just to make an unreasonable amount of money in a short period of time. This might work out well sometimes but when it backfires it is always very disastrous.
Traders are expected to take calculated risks and not totally absurd or unreasonable ones as it always spells disaster.
Let’s also illustrate using another example: Williams is an upcoming trader who has had some good success in the market and is looking to further increase his portfolio with more profitable trades.
He started his trading journey with an equity of $10,000 and has grown it to 100% profit bringing his current equity to $20,000 in just 4 months which means Williams makes about 25% profit monthly, a very steady and commendable growth.
Now he starts targeting $100,000 in the next 2 months due to his growing lifestyle. This already shows that Williams is getting greedy which is not a good sign.
Now Williams on a particular occasion takes a trade where he uses 75% of his equity i.e., $15,000 for the trade, his TAKE PROFIT is set at 25% profit which is $3,750 dollars in profit for the trade.
After a while Williams comes to check his trade and finds out the 25% profit is almost attained, he looks at the market and feels that the market would still keep on moving in his favor for a long time and then readjusts his TAKE PROFIT position to 50% ignoring the 25% he set earlier.
He leaves his trade and when he comes back he discovers that the market has reversed and gone against him, taking him into a loss of over 30% already, he becomes disappointed and eventually leaves the market with a loss.
In this scenario, William’s greed has cost him to lose some of his equity in a trade when he was supposed to make a very good profit.
This is only one scenario where greed is illustrated, there are different ways greed affects traders’ decisions, sometimes some traders would use very unreasonably high LOT SIZES so they can quickly make great profits or use very high leverages.
All these have led to several traders blowing their accounts and incurring serious losses.
What happened to Williams can also further make him lose more money if he doesn’t control his emotions and allows anger or frustration to set in, he might want to do what we call ‘REVENGE TRADE’ where he would try to recover what he lost in the market by even trying to take more unreasonable risk to make up for the losses and also make more profit.
This is not advisable at all because as a trader, your mind must and should be open, so you can understand and see the market from a broader and clearer view, if your judgment is clouded with anger, frustration, or revenge, you would end up losing more money to the market and the market definitely does not care.
You should know this, nobody is the master of the market, at least not when you have very little liquidity rather the market is the master, all you need to do is calmly face it, understand it, and then benefit from its flow.
This is another trader’s killer which without a proper forex risk management strategy will in most cases ruin a trader. This especially applies to upcoming traders who have not yet established themselves in the FOREX market.
Fear allows traders to miss out on opportunities, and lose money from trades due to the fact that they may exit trades prematurely, when they see that the trade, they entered is incurring little losses already and they are losing their funds, fear can also make traders enter a trade prematurely when they feel they would lose out of whatever opportunity they see brewing.
When this fear affects a trader over and over again, they end up blowing their equity and find it difficult to trade again because they develop a phobia for trading in general.
I have seen this happen severally in my trading journey and it’s something every trader must and should guard against. Like the previous 2 emotions, I would give an illustration of how fear can affect you as a trader and how to guard against it.
Let’s use Ese as a case study: Ese is a beginner forex trader and he has just funded his account with $100, he decides to enter into a trade after he has carefully analyzed the market, and he decided to risk 50% of his equity for this trade and also ensured that he placed his STOP LOSS & TAKE PROFIT price using his broker.
After a while Ese comes back to check his trade and sees that the market is currently going against his speculation and he is incurring a loss of about $3 already, this makes him question his own skills and speculation and he decides to exit the trade because he is afraid of losing more money.
After exiting the trade, Ese comes back in an hour’s time to check the same instrument he just stopped trading and sees that the market direction of the instrument has started moving towards the direction he speculated but unfortunately, he has exited the trade and even incurred a loss.
After discovering that the trade has started moving towards his previously speculated direction, Ese developing FOMO fear of missing out on the opportunity on which he has incurred a loss initially, recklessly enters into the trade again and this time goes all in, using all his equity in the trade and increasing his LOT SIZE so he can recover the money he lost in the previous trade.
After entering into the trade, Ese comes back to check the trade and discovered that the position he entered the trade was a very wrong position, where the market was having a pullback, therefore he discovered he was already incurring more losses at this point and rushes out of the market to avoid further losses.
At this point due to the fact that he used a bigger LOT SIZE, and all his capital, his losses are more than before losing more than half of his equity.
From Ese’s action, you can see that FEAR is an emotion that would affect every trader if they are not disciplined.
To curb these emotions while trading it is very important you have a TRADING PLAN and use funds you can afford to lose, or equity that won’t put you under undue pressure while trading. We would be examining what it takes to have a TRADING PLAN next:
Having a Trading Plan
Another one of the Risk management strategies is having a trading plan. Just like the popular saying, ‘if you fail to plan you are planning to fail’.
Every Forex Trader must understand the fact that they need to have a working Trading Plan before they can even think of becoming successful in Forex Trading.
Every Successful and professional Forex Trader has their trading plans which they have tried and tested over time till they are able to work with it and confirm it’s sustainable.
There are some basic factors to consider when trying to create a trading plan and I would be highlighting some of these factors.
Firstly, every trader must and should know that their emotions cannot change the trajectory of the market as they don’t have the ability to influence the market movement except if they own billions of dollars, therefore utmost discipline should be inculcated in their trading activities as this would ensure that they stick to whatever Trading Plan they have created for themselves.
The first thing you need to consider after your training process as an aspiring trader is your capital base.
You should ensure that the amount you would use to start your trading journey should be something that you can afford to lose or do without over a period of time.
Most individuals put in money they were supposed to channel into other important things into forex trading hoping to make some quick profit on the funds and then take back what they put in. This is a bad idea because you would be forced to trade with emotions and end up losing your funds.
Therefore, if you are ready to start trading, it is advisable you don’t put in borrowed funds as it is already the beginning of trading failure. Look for a way of getting a dedicated fund, however little it might be to fund your forex broker account so as to trade comfortably and not emotionally.
This way you are able to gradually grow your funds without anxiety over a period of time.
In our next article, we will be talking about other important forex risk management strategies that can really help a trader in their quest for a profitable forex trading career.
To see more risk management strategies click here, or go through our trading education category. I hope you have been able to learn a bit more about how to improve your chances of success in forex trading, through the risk management strategies we have shown to you.