Forex trading is a risky business. Traders employ risk management strategies to cut potential losses and soften the blow of bad trades. If you’re a beginner investor, it is critical that you do your homework to make informed and confident investment decisions. Part of this due diligence involves understanding your options in risk management. To make your job easy, we have outlined a few of the most popular risk alleviation strategies.
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Determine your position size
If you have a larger account of $500,000 or more but you don’t want to risk more than 1% on every trade, you can use a fixed dollar-stop. So, if your maximum stop is $1,000 and the distance to your stop from the entry price is 50 pips, you can have two standard lots or 20 mini lots.
Use reasonable leverage
There is a direct relationship between leverage and how it impacts your account. The more the amount of leverage used, the greater the ups and downs in your account equity, and vice-versa. So, lower or reasonable leverage is advised as a cautious risk management strategy.
Manage risk-reward ratio
Traders often lose more money on losing trades than they make on winning trades. A 1:1 risk reward ratio is an ideal one to follow as it can greatly minimize your risk in a losing trade. With this risk management strategy, even if you’re right 50% of the time, you will at least break even. Say you’re targeting a profit of 90 pips with a risk of 45 pips, then your risk to reward ratio is 1:2. That means you can be right about just half of your trades and still make a profit as you will earn more on your winning trades than lose on your losing trades.
Explore the 2% rule
The 2% rule is simple : don’t risk more than 2% per trade. Losing 2% for each trade means that you will have to suffer 20 consecutive losing trades to wipe out 20% of your account. This is a bit of a stretch, and even if you experience such a terrible losing streak, 60% of your capital would still be left unharmed. Say you trade $1,000 and lose half of it, bringing your capital down to $500. You would need to make a profit of $500 (100%) to break even. If you lose 75% of your capital, you’ll be staring at a 400% return to break even, which is a very unreasonable expectation.
Exit at profit targets
There are many more risk management strategies as well as iterations of traditionally-followed strategies. It is in your best interests to understand how they work and their benefits to make informed investment choices.