Algorithmic trading system ideas and educational articles for automated trading.

How to Deal With Risk in Forex Trading

Forex trading is a risky venture, especially for trigger-happy rookies who blindly buy and sell without proper risk management. And while the common investing proverb – cut losses short, let winners run – sounds like a simple enough strategy even for beginners, the reality is oftentimes the opposite, with losing positions amounting more than winning positions. Fortunately, risk can be easily tamed. Here are six tips to minimize risk and, concurrently, maximize financial gains.

Know the Trade

As Warren Buffet puts it – “risk comes from not knowing what you’re doing”. Not knowing enough information about the trade means you cannot clearly see risk versus reward. Trade currencies whose economies you have clear understanding of. Read up on what their central bankers are planning to do about interest rates, what employment and unemployment numbers are being printed, and how consumers are generally behaving.

Always Use a Stop Loss

Most, if not all, trading platforms have a built-in stop loss feature that you can set either by dragging and dropping a line on a price chart or by inputting the price levels yourself on the trade’s ticket. A stop loss is used mainly to close a position automatically once it hits a specific price level. This removes the need to manually close a losing position, which at times can be very difficult to do. A stop loss can either be fixed or trailing, which automatically adjusts a fixed amount of pips every time a winning position moves.

Use a Reliable Trading Platform

The best Forex trading platform is one that can execute trades at lightning fast speeds every time. During volatile times in the market, you’ll want the ability to get in and out of positions without having to wait for your broker to fill the order. Even a one-second delay in your order can cost you money from extending the losses of an already losing position or missing out on a better price point when entering a trade.

Leave Your Emotions at the Door

This is probably easier said than done, but it’s an integral part of managing risk in forex trading and is something you’ll want to learn, and learn fast. Greed and fear of missing out are two of the main culprits that force people to hang on to trades far longer than they should and open positions that they know are too risky to begin with. There’s simply no place for human emotion in forex trading. Even bouts of happiness brought about by a winning position can cause you to be overly confident about your abilities to guess which direction the market is going, which will ultimately end up in losing trades.

Schedule Your Trading Activity

Similar to how you run a business, forex trading should be done at specific times. If you leave yourself looking at price charts hour by hour, Monday to Friday, you’ll merely get tempted to open risky positions. And after those positions lose, you’ll try to compensate by opening more riskier trades. This vicious downward spiral will continue on until you eventually dry your account. Most traders are active during the daytime hours between 8:00 AM to 12:00 PM since this is when the New York and London exchanges overlap.

Have a Higher Reward to Risk Ratio

A 3:1 reward-risk ratio on your trades means that you can potentially make $3 for every $1 you risk. The higher you set your reward-risk ratio, the fewer trades you need to win to profit over time. For instance, if you lose 70 of the 100 trades you take, with a 3:1 reward-risk ratio and assuming that you lose $1 for each of those 70 trades, you still come out with a profit of $20, which isn’t bad for a 30 percent success rate. It’s tempting to scalp or day trade in Forex since there’s usually enough short-term volatility to pocket a few pips up and down, but the risk curve grows exponentially over time.

Final Thoughts

Dealing with risk in Forex, or any financial market for that matter, is inherently difficult because of how humans are biologically programmed. People love the idea that they can foresee where market prices are headed into the future. They also can’t accept the fact when they are wrong and will try to hold onto a losing position as much as they possibly can until they get margin called by their broker. To improve your trading performance, mainly your ability to manage risk, it’s imperative that you first work on the emotional or psychological side of it.