Trading comes with a certain amount of risk. There is a thin line between keeping your losses at a minimum and raking in monumental profits. With little knowledge of risk management, many forex traders end up with huge losses.
It is important to learn how to manage risk even before you begin trading. The forex market ranks high on the list of the largest markets on the globe. Billions of dollars are traded every day. Therefore, individuals as well as institutions have the potential to make huge profits.
A trading platform such as MetaTrader4 offers you a plethora of forex trading tools. Also, users have access to risk management skills such as the ones we will discuss in this article.
What is Forex Trading Risk?
All investment comes with potential risk. Whether you are trading stock, options, or forex, there is always the possibility of losing money. Forex trading risk, simply put, is the possibility of losing money when trading forex.
Risk in forex trading includes the following:
- Interest Rate Risk: Interest rate can impact negatively on the value of the affected economy’s currency. Then forex traders would be at risk of unanticipated changes in interest rates.
- Market Risk: The market may perform contrary to your expectations. This is a common risk in the money market. You may expect a currency to increase against another only for it to nosedive. This would result in a loss.
- Liquidity Risk: A currency pair with high liquidity has more supply as well as demand. Trades for such a currency pair is executed fast. Currency pairs with less demand do not trade as fast.
- Leverage Risk: Leverage allows traders to open trades that are larger than the capital in their trading accounts. This could lead to loss as the trader may lose more than what they initially deposited in their account.
- Risk of Ruin: You could run out of funds to execute trades.
Managing Forex Risk
- Arm Yourself with Information
There is a lot of information that you can access online. Also, keep updating your knowledge so as not to be caught unawares. There are lots of webinars, articles, and videos that can give you the information you need. You can also take a trading course online and learn from the experts.
- Stop-Loss Orders
A stop-loss protects your trades from unanticipated market movements. It allows you to automatically close your trade when it goes down to a preset amount. This protects you from making monumental losses and depleting your account.
Note that stop losses do not protect you against slippage. This is when the market runs amok and results in price gaps. The stop-loss order fails to execute at the preset level but will activate the time it does reach the level.
- Take Profit
A take profit closes a trade once they get to a preset profit level. A trader should have candid expectations for each trade and set appropriate risk levels. Simply put, determine the profit level, as well as the loss level, and be disciplined about them.
- Only Risk What You Can Afford to Lose
Many new forex traders make light of this rule and learn the hard way. The money market can be very unpredictable. If you risk more funds than you are comfortable losing, you put yourself in a very vulnerable position.
Covering your lost forex capital is quite difficult. You have to earn back a great fraction of your account to cover your loss. To avoid this, calculate the risk involved in FX trading before you even start.
- Control Your Use of Leverage
Leverage is double-edged in that it can amplify your profits as well as your losses. This heightens the possibility of risk. If the market moves as per your expectations, you stand to make a profit. If not, then you will make a loss.
Risk management in forex trading will depend largely on your preferences as well as tolerance level. Seasoned traders have learned not to trade with emotion. This leads to errors and you may end up losing more than you gain.