Learning and mastering risk management is the key to succeeding as a Forex trader.
Rookie retail traders and investment bankers can use all the technical indicators they want and study macroeconomics in great depth, but at the end of the day, it’s how you manage risk that makes the most difference to your bottomline.
Yet since most people’s minds are innately programmed to succumb to fear and greed, it becomes challenging if not impossible for a lot of people to master risk management.
If you’re having trouble cutting losses short, here’s seven tricks on how to master the simple yet illusive art of risk management.
Establish Hours of Trading
Just like a small business is open at fixed hours during the day, you should also have fixed hours for when you analyze and trade the foreign exchange market. Since Forex is open 24/5, it’s easy for amateurs to just start blindly buying and selling currencies without a real viable plan.
By setting hours of the day for trading, you limit the number of trades taken and therefore any broker fees and capital losses incurred in the process.
For instance, if you decide to only trade during the morning session i.e. 8AM to 12PM, you avoid the volatility that occurs during the rest of the day.
Set Stop Losses and Go
A stop loss is a mere visual line on your FX trading platform, but it’s a powerful safety measure that minimises losses in the event that a position goes awry.
The problem with stop losses is that they aren’t permanent and a trader can keep moving them deeper and deeper just so that their losing position doesn’t get closed by the broker.
Determine a stop loss even before opening a trade. Make sure to figure out the appropriate stop loss based on the dollar risk being taken relative to the account size.
For a $1,000 account, for instance, a $50 stop loss denotes a 5 percent risk for just one trade. For that trade to be valid, you’ll want at least a 10 percent potential gain from that trade. Once you’ve set a stop loss, exit the chart and let the trade go.
Invest in Value
Value investing helps you choose financial assets that have a high probability of success over time. Do what Warren Buffett and other value investors have been successfully doing for decades – buying low and selling high.
Instead of thinking about risk as a go/no go signal, like how a lot of people do, think about it as the probability of losing your initial capital.
To Buffett, risk is unrelated to market volatility. If there is a good chance that you’ll lose money on a financial asset, then look for opportunities elsewhere.
Demo on a Dummy Account
As attested by Brian McAboy of Inside Out Trading, one thing you need to succeed is adequate training. There’s no better way to get training than with a demo account.
It’s where you can introduce yourself to how broker platforms work, where the controls and options are, and what it feels like to take care of an investment account.
Experts advise beginners to trade on a demo account for at least three months before opening a live account. And while a demo account can’t really prepare you for the mental and psychological stress of trading, it gives you the opportunity to test technical strategies as well as practice risk-taking.
You can experiment on different account sizes, position sizes, and risk per trade. Simulating this 100 times or so can give you a clearer idea of what works and what doesn’t.
Journal All Your Trades
Journaling is a good practice not just for learning how to trade forex, but for other activities as well. Journal every detail of your trade, down to the slightest and seemingly insignificant ones like how you felt while opening the trade.
Jot down economic reports that were being released at the time your trade was open, what market patterns were forming, what participants were doing, and so forth.
You can keep the information on a notebook or start a blog of your own. Forums on investing-related websites are also good places to write down your trades. It lets others see your mindset and style of trading, and experienced traders who went through it can give you feedback.
Wrapping it Up
Forex trading is all about numbers and probabilities. There’s no guarantee that your trade will make money, regardless of how many technical indicators you stuff your chart with or which successful trader you listen to.
It all boils down to managing risk and making sure each trade you take is worth taking. By following the five techniques above, you can quickly master risk-taking without the substantial losses or the headaches and frustrations that come with the learning curve.