Forex Trading Risk Management
It is a well known saying in Forex trading that “If you control your losses you will eventually make profits.” In Forex trading, the importance of risk management is very high because of the high level of leverage almost all the Forex brokers provide to the traders which makes it a highly risky trading system. High level of leverage not only enables a trader to take huge trades which can make a lot of money but it also comes with a risk of losing all your investment in one single trade.
There is a very thin line between gambling and speculating and a successful trader should always understand this factor of difference between gambling and speculating before starting to trade in the Forex market. The only difference between gambling and speculating is the level of risk. In gambling, there is no control on the risk by the gambler but in speculating there should always be a controlled risk in every trading decision. A speculator always takes a well calculated and controlled risk but a gambler tends to play blind which can result in a huge loss. Speculating as a professional Forex trader is not gambling as a trader always manages the risk first before entering into a trade.
In this blog, we will try to understand the basic trading styles and the factors which affect the level of risk associated with a trade. We will also explain the basic but most important trading strategies which can enable a trader to trade in the market with the best possible risk-reward ratio.
Basic Trading Strategies
There are two basic trading strategies or three different ways to take a Trade the first trading style is the Martingale strategy. In Martingale trading style a speculator doubles his trading bet each time he losses in a hope of getting back all the money he lost in the previous trades in one single profitable bet.
The second trading style is the anti-Martingale speculating strategy in which a trader doubles his trading bet every time he wins a bet to not only set of all the previous losses but to make higher profits as well.
The anti-martingale strategy is widely used in the Forex market, as it is always a wise decision to take your losses quickly and increase your trade amount in a winning trade to get the most out of the market movement.
Fundamental & Technical Analysis
As we have learned above that the only difference between gambling and speculating is the controlled level of risk and a higher chance of return than risk. And to make this thing possible and in order to make money out of the market, a trader should always learn the basics of technical and fundamental analysis to generate money out of the market easily.
The technical and fundamental analysis is a very useful tool to make money in the forex market as it enables traders to not only take an informed trading decision but it also helps them to assess and control the underlying risk in the trade to avoid any unexpected losses.
The technical and fundamental analyses help a trader to choose which pair to trade and when to trade. It also helps in identifying the price points where market reacts and this plays a very important role in deciding when to close a trade.
Liquidity is one of the most important factors which affect the level of risk in trading. Liquidity is the measure where you can assess the numbers of market participants in the market to take actions and response in the market. In simple world a higher liquidity enables you to close or open a trading position quickly in the market which means you do not have to wait to close or open a position if there is a high liquidity in the market and if the liquidity is less then you may face problems in opening and closing your position as there is not enough supply or demand of that security in the market at that point of time which can result in a loss.
But in case of Forex trading, there is a negligible amount of liquidity risk involved in trading if you close to trading in the major pairs like EUR/USD, USD/JPY, GBP/USD, USD/CAD etc as there is ample volume in the Forex market.
However, this doesn’t mean you always get a good level of liquidity with all Forex brokers and that is where the need of choosing a good forex trader arises. As a broker not only can play with your open position but brokers can also hinder the level of liquidity as the liquidity available to your Forex broker have a direct impact on your accounts liquidity. A Forex trader should always work with a well-capitalized Forex broker to have enough liquidity to effectively execute and close trades efficiently.
Rewarding Risk and Reward ratio:
Selecting a well suitable and researched risk and reward ratio is a very important factor which has a very large impact of the risk factor associated in forex trading.
A well studied and suitable risk and reward ratio is a very important part of a profitable trading system. A trader should set a risk and reward ratio after considering all the important factors of trading like market movement, risk apatite, trading signal accuracy, and profit expectations. A good and well-researched risk and reward ratio is the backbone of any trading system.
Every trader should set the risk and reward ratio according to the risk-taking capacity and the accuracy of the traders trading decisions. For a new trader whose trading decision is not very accurate, he should keep his trading risk and reward ratio higher so that if in a losing trade accuracy will reach 50% also then too he will not lose his investment.
Selecting the Level of Leverage:
Forex is a highly rewarding market for day traders as it gives them a massive amount of leverage to trade in the Forex market. A trader can enter in big trades with a very small amount of investment with the help of high level of leverage Forex brokers provide to the traders. This huge amount of leverage is a very tough thing to manage as a misuse of it can lead to huge losses even traders can lose their whole investment capital in only one wrong decision.
Because of this managing, the level of leverage according to the risk-taking capacity is very important in Forex market not only to prevent huge losses but also to optimize the available leverage efficiently to make money out of the market.
A risk is a stubborn part of every, it always come hand in hand with the level of reward you can make out of a trade. Knowing, measure and managing risk is the most curtail part of trading as this will decide whether you will make money out of the market or the market will take all your equity and make your account zero. Overlooking risk can result in a heavy loss and even nullifying your profits and it can also eat your investments. However, with a disciplined approach and with the help of fundamental and technical analysis, anyone can control the level of risk associated with the trading business. Good trading habits, a well-researched risk and reward strategy and optimum utilization of leverage and liquidity can result in highly successful and profitable Forex trading by generating good returns with minimum possible risk.