Forex Risk Management Strategies

Published: 2024-01-25 00:00:00

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Everyone expects foreign exchange (Forex) trading to be easy and very lucrative. However trading in the forex market does have quite a few pitfalls. So let's make your experience with Forex better.

1. Picking the right type of account: Picking the right type of account shouldn't be hard. However, it can be the first trap when learning to trade. Some brokers will give you their default Forex trading account which usually has really low spread costs but have extremely high commissions. So when opening a trading account make sure you open a spread only trading account. This will save you a ton on money over the course of the year.

The main difference is the type of trader opening the account. If you are a day trader (i.e someone who is only intending to be in a trade less than 3 days), then the default account could cost you less in daily finance fees. However, if you are a buy and "hold until you win" trader, the spread account is your best option.

2. Only play with money you do not need: A lot of people fall into this trap hoping to get rich quick. Forex is a patience game. Draw down happens, so be prepared to either take a loss or wait for the position to come back. You will either trade time for money or money for money. Trading with money you need to live on adds additional emotional damage, stress, and anxiety to the whole experience.

3. Risk tolerance: A lot of things factor into your risk tolerance. For example: 

  • Your age

  • Your investment goals

  • Your ability to make critical decisions under pressure

  • Your knowledge and experience trading

And if you have no experience:

  • How much are you willing to lose? 

  • How much time?

  • How much Money?

We don't want you losing sleep, so figure out these questions before you attempt to trade by making a trading plan and then stick to it.

4. Make sure your risk is worth your reward: This is where you need to make a decision. Scalpers and day traders typically have a risk reward system that goes like this. If I am attempting to make 50 pips I am willing to lose only 25. Traders who want to stay in the trade longer adjust this ratio slightly by possibly raising the reward to 3-5 times the risk stead of just double. So for example, a long term trader may have a risk reward ratio that is for every 150 pips I am trying to collect I am willing to cut my losses at 50 pips. So their Risk Reward Ratio is 3:1 while a scalper or day trader is typically 2:1.

5. Manage your risk on each trade: Keep the size of your positions small. The reason for this is to reduce the amount of drawdown on the account. Typically 1-2% is safe, but risking 10% of your portfolio on a single trade could result in you running out of capital due to drawdown. Consistent wins are more important than large ones. And just because you're winning does not mean you should change the size of your next position. Keep your positions consistent as well.

6. Leverage is and is NOT your friend: Just like everyone likes to be a big winner, no one likes to be a big loser. So make sure you know and understand the leverage on each pair you want to trade. Exotic pairs and minor pairs can be very tempting, but if the leverage is too high, you might find yourself in a margin call. Stick with the major pairs and diversify which pairs you are trading for best results. 

For example, let's say you are trading two pairs that end in USD. If the dollar has a good day ,and you're selling these pairs, you will win big. However, if you a buy position open on these two pairs, you're probably going to have a bad day. 

7. Get the biggest bang for your buck: Different pairs have different buying power. For example, currently 0.62 of a US dollar will make one New Zealand dollar. And currently, 1.27 of a US dollar will make one Great British pound. In this example, I can either spend 1.27USD  to buy or sell and control 1 Great British pound or I could do the same in New Zealand and control 2 of their dollars - which makes my reward per pip twice as large. 

Hopefully these few changes in how you could trade have been helpful. If you like what we've said here, share with a friend and let us know on our social media!

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