Forex risk management is a crucial aspect of trading. Without a solid risk management strategy, you can lose all your trading capital. Most of the unsuccessful stories associated to Forex trading are given by traders whose accounts were managed without a proper trading risk management plan. As a trader who is motivated and determined to build a profitable Forex business, you cannot ignore the importance of trading risk management.
Hopefully, you will find a few useful ideas on how to reduce Forex trading risk as you continue reading this write-up.
In the simplest terms, risk management consists of ideas and actions for protecting an investment from losses. In Forex, it can include limiting the trading lot size and trading times, hedging, and knowing when to exit a trade position.
Responsible Forex Traders Take Precautions
It is undeniable that there are some trading methods and strategies that have been proven to work. However, a trader needs to always remember that no human, computer, signal service, backtesting software, or trading system that is perfect. No matter how much something has been endorsed by whoever, in Forex trading things can turn the other way quite abruptly. This is why you should always put your guard on, exercising caution in every decision.
Here are 5 Forex trading risk reduction tips for successful trading:
1. Thinking Through Market Hype
It is common practice for Forex traders to subscribe to several market information sources. While it is a good thing, the daily bombardment of “buy” and “sell” messages can impel a trader to make a trade decision without thinking properly about it. Even when it seems like everyone else out there is making money, don’t just take action because the charts are screaming at you.
Remember that the money at risk is yours, not your broker’s or your news provider’s. Thinking objectively amid the hype is a big challenge for many traders and probably the major factor differentiating successful and frustrated traders. Learning to resist the pressure of trading emotionally helps to avoid unnecessary trading risk.
2. Trade longer time-frames/avoid high frequency trading
Shorter time-frames are generally more volatile than longer time-frames. The higher level of unpredictability of shorter time frames makes trading them more stressful. Trading short time frames is also less profitable due to trading fees. Longer frames like the hourly, 4-hourly or daily chart provide more certainty and are less stressful. You have relatively more time to plan trades. Trading longer time frames is also more profitable since fees and slippage are lower.
3. Trade markets that have low correlation
Trading uncorrelated markets or those with low correlation follows the idea of diversification. In all kinds of investment, diversification entails holding investments whose returns and risks don’t follow the same direction. It is a way of reducing the overall risk of the investment portfolio. You don’t want your holdings in a Forex trading account to move in the same direction because you will have no protection in case the market turns in an unexpected way.
Many currency pairs have high correlations, meaning that when one currency trends in a certain direction its counterpart moves in the same direction. Holding highly correlated currencies concentrates risk rather than lowering it. It is a good practice to diversify your account with currency pairs that have low correlation.
4. Study money management
Managing risk in Forex means managing money on a daily basis. Understanding how to manage trading capital effectively is the most essential tool of minimizing losses and maximizing profits in online trading. Successful Forex trading is not just about pumping in big money to earn big profits. Without proper money management skills even a million dollar trading account can run dry in a matter of days. Commit to mastering money management principles such as:
- Start with a small capital and grow your account as you learn
- Use a demo account before trading with real money
- Use correct stop losses to minimize trading risk and thus protect your profits
- Keep your leverage low
- Accept your losses and move on swiftly
These are just a few money management tips for Forex trading.
5. Trade using a regulated Forex broker
Fraud is not a stranger to financial markets. Forex trading, therefore, has an element of risk due to the possibility of being involved in a fraudulent scheme. The last thing you want is to lose your hard-earned capital to a fraud dealer. Do thorough research on your desired broker before opening an account with them. Ensure that they are registered and regulated by relevant authorities. Forex broker reviews can be of great help when you are doing your due diligence.
As the currency market keeps changing, so do the Forex risks that a trader faces. Managing trading risk effectively requires one to have a clear understanding of the risks and a strong plan of how to reduce them when making trading decisions. The above tips should help you put up a risk management strategy that will support your success in Forex trading.