When an individual decides to take on trading, it’s for one reason, and one reason only, TO MAKE A LOT OF MONEY! These days, social media has idealized the trader lifestyle to the general public, and there are more individuals trying to get involved in the financial markets today, than ever before! People have begun to believe the freedom to buy what they want, and travel whenever they like, is so closely within their reach – and that trading is the key to get that. What they often fail to consider, is the flip side; if you can make a lot of money doing something, then you most likely can lose a lot of money doing it as well. This where Risk Management comes in.
There is no better feeling, than watching the returns roll in on a trade, when you have taken the correct position. But in contrast, there is no worse feeling than watching your capital being eroded down by some lousy, misjudged trades. This is why having a solid risk management strategy in Forex trading is so important. When you have worked hard to earn the capital you have invested in a trading account, you want to protect that capital from diminishing, and better yet, earn some profits and grow that capital. At any point, if you're doing well and have grown your account, you are still exposed to the grasp of the market, and your returns are vulnerable to heavy losses. It is the ugly truth.
So, what does this mean for you as a trader? It means you need to be highly selective! The best traders focus more on protecting their capital as they know set-ups will always happen in the market (Forex is not going anywhere), so don’t force a trade, or force yourself to believe something is happening on the charts, that actually isn’t. Criteria, criteria, criteria! As a trader, make yourself a checklist of the criteria you are looking for in a trade, and ONLY take that one trade, or handful of trades that match the criteria on your checklist. If something is off, even just a little, forget about it, you don’t need that risk in your life, when something else will come around with a much higher level of certainty.
Don’t know what a stop-loss or a take-profit is? Read our Forex Foundations eBook, it is free for God sakes! Stop losses are a tool that traders use to essentially pull themselves out of a trade, in the event it is not going in their direction. A take-profit is essentially the opposite, if you are in a trade, you can place a pending order at a point in price where you would feel safe collecting your profits and exiting the trade.
Let’s get into an example to demonstrate the importance of stop orders in risk management. You as a trader, enter into an order, and you have a stop-loss placed 20+ pips opposite the direction of price to where you entered an order. This means your maximum potential loss here, is the equivalent of your lot size x the number of pips opposite to your entry price. That means, if you have $2,000 in your trading account, and you are trading $10/pip, essentially you are risking 10% of your account on ONE TRADE. Believe it or not, this happens all the time, and that is why high pip stop losses are a very common way people blow their accounts. When it comes to stop losses and take profits its key to have a strategy where the ratio is in your favor as a trader. As a general guideline, make sure your ratio of potential loss to potential gain in an order (based on take-profit to stop-loss) is at a minimum 1:1, and more preferably a 2:1 or higher. Logically, you want the potential to make at-least the amount you are willing to lose on a trade.
When things don’t go your way in the market, you will be frustrated, upset, and start making poor decisions, taking lousy trades. Your emotions will cloud your judgement, and the avalanche of losses will begin to occur. At this point, the only way to “get back at the market” or truly get even, is walk away from the charts, clear your head, and go back to your strategy. That might not even happen during the same trading session, you may need to wait until the next day to get back at it. But that is the only way you can come back and trade with an unaltered mindset. We spoke in-depth about the psychology of a trader in our last blog post, and we can’t stress enough, the importance of a clear mind while trading.
For more on risk Management email firstname.lastname@example.org or DM us on Instagram @nVestFX. Our courses go over the different ways to protect your capital and have your account going in the right direction and remember, every trader takes losses.