Managing forex risk is vital to make the most of your trading journey. Risk management in forex trading is essential to ensure you are covering the necessary angles to protect yourself in the event of market volatility.
Risk in forex trading can operate similarly to cryptocurrency trading or commodity trading, such as silver or gold. By following a few simple instructions whenever you trade or invest, you can mitigate risk effectively. If you are at the beginning of your trading journey, you will be eager to find ways to manage this risk, especially if you are not fully versed in how the market operates.
However, do not worry. Help is at hand. We will advise you of the risk management tools many professional traders use to support their trading strategy. Contrary to what some may believe, the key to making money in forex trading boils down to several factors. So let’s take a look at a few.
Understand The Market
Nobody has a crystal ball. However, allowing ample time and arming yourself with a good knowledge of forex markets is crucial. A good place to start would be to explore what currencies have the highest and most consistent trading volume. It’s no secret that the US Dollar remains the number one currency in the world. It carries huge buying power and is an apex for many other foreign currency pairs.
Other currencies that intertwine with each other in this multi-trillion dollar marketplace include the Australian Dollar (AUD), the New Zealand Dollar (NZD), the Euro (EUR) and the Great British Pound (GBP). The Japanese Yen (JPY) and the Swiss Franc (CHF) make up the other top currency pairs. Establishing what drives these specific pairings is key to understanding the market.
There are plenty of news outlets specializing in forex focused news. Bloomberg & Financial Times are just two examples of high-quality finance news you can find. Performing the necessary groundwork to build your knowledge should be part of a multi-faceted approach that you implement.
Understanding forex risk also includes knowing how the markets may react to certain news and what economic news could drive the price of a foreign currency up or down.
Stick To Markets You Understand
This section segues from the previous section. Understanding forex is essential to begin trading it effectively. However, some traders might be tempted to move into other markets if they see that is where the money is. We aren’t saying this is a bad idea, but it is imperative you understand exactly how other markets work.
For example, if you spend multiple months or years studying forex markets, how they work and what drives them up or down, don’t allow yourself to become fixated on the price of Bitcoin suddenly. Even if that market proves to be more profitable than forex, you are essentially gambling if you don’t understand how cryptocurrency works.
Some traders will trade multiple assets as they have spent time and effort researching how they behave. However, just because you understand how foreign currency works doesn’t mean your trade will succeed. As we have already discussed, risk management for forex is just one part of a bigger strategy.
Your capital is always at risk when you trade, which is the case whether you are trading commodities such as gold, cryptocurrency, forex or stocks. Considering what we have discussed today are variables that will not work against you, they are all in good practice and are implemented by professional traders to varying degrees.
Set Yourself Limits
Being able to set yourself up with ceiling limits on both your profit and loss is essential. It provides structure to your trading psychology and allows you to manage your trade’s outcome better.
Having the ability to identify where you wish to take profits is ideal. Where you want to place your safety net is the key component that defines trading as a skill rather than gambling. There are other factors too, but this is the main variable determining the set difference between the two.
Each trader has their strategy and method which they use. Even though many may employ generic strategies such as swing trading or day trading, the limits you set within these strategies will state whether you have more appetite for risk or less appetite for risk compared with other traders. Forex risk management strategies vary. However, in a broader sense, many traders will use these more established methods to set targets.
A forex manager at a large investment bank will likely handle portfolios worth a large amount. Sometimes these amounts are in the hundreds of billions and will often set safety nets and levels to take profit. If you read other articles on this topic, you may also hear it referred to as fx risk management or forex mgmt. However, it means the same thing. Fx is used as an abbreviation of forex, and management is shortened to mgmt.
How Can I Use Software For Risk Management In Forex
One of the main issues that cause traders to slip up is when they allow negative emotions to play a pivotal role in their trading method. However, by using stop loss and take profit limits, you manage this risk effectively. Removing emotions by using automated software will allow you to focus on analytical chart study and other factors that drive the market.
Ensuring you enact a strategy that ensures your risk management in forex is at the forefront of your method could be the difference between making money and losing all of your initial investment.
You don’t need to keep yourself cemented to daily price action or chart movements; you can rest easy knowing that if your price drops below your stop loss range, you have set up a limit to counteract it. A forex risk management strategy needs to have many different facets to have the best chance of success.
Likewise, if you are in a position where the markets are looking more positive, your asset will be sold at your take profit level and executed accordingly. You can use this software across a range of assets, including MetaTrader.
Is Risk Management In Forex Trading That Important?
It is reasonable to suggest that managing risk is beneficial in any walk of life. If you are looking to book a hotel for a weekend break or a summer holiday, you want to ensure you are booking the right place for your needs. You want to investigate whether it suits you before booking the first hotel you find.
Risk management in forex works the same way. Blindly trading a US Dollar/Japanese Yen (USD/JPY) without doing prior research and finding out each country’s current economic climate is something the vast majority of traders would advise against. Proper risk management forex methods aren’t just advisable; they are indispensable.
Risk in forex will never disappear, nor will it disappear in any other trading market. Ensuring you learn how to mitigate these risks and handle the volatility accordingly is the optimum way to try to turn your venture into a success.
Forex Risk Management Chart
Earlier, we discussed automatic buy and sell orders. So that this advice doesn’t sound too generic, we will detail on the graph below how it takes shape and where traders may enter or exit the market. Risk management in forex constitutes applying common sense as well as chart analysis.
As you can see on the self-explanatory graph above, there are entry and exit points to insulate yourself from greater losses. Risk management in forex is what we are focussing on today.
Forex Risk Management Lot Size
One of the more common terminologies regarding risk management in forex is “lot size”. A lot size is a large measurement of a specific currency in units. For example, if the GBP/USD pairing is trading at 1.21, the standard lot size of the GBP is 121,000 units.
Institutional investors like hedge funds often use lot sizes to deal in significant amounts of currency. Their risk appetite is much bigger than a retail investor who trades with a much smaller capital and will tend to use their funds instead of a huge amount of specified currency, the type to which large investment banks have plentiful access.
Managing fx risk is important for these companies as they operate in billion-dollar trades, which can shape the market. For anyone who operates uniquely in this market, risk management in forex needs to be managed with every trade and every day to ensure you know how to operate properly in this volatile trading area.
Forex trading management encompasses various strategies, some more successful than others. However, risk management in forex is critical. You’d be hard-pressed to find traders who have made a living out of trading and have zero risk management forex trading methods.
We have touched on some main points today, and hopefully, you now grasp the importance of risk management in forex. As long as you can properly assess your risk appetite and combine it with the variety of factors we have touched on today, you will be able to use it as an adequate springboard to enter the forex market with a fair degree of confidence.
As we touched on, though, and as we must reiterate, effective risk management in forex doesn’t translate into guaranteed profit.