A Simple Guide to Foreign Exchange Risk Management

The first step to managing the risk of trading in the currency market is to determine the odds of executing your trades successfully.  In order to determine the odds, it is necessary for you to have an understanding of technical and fundamental analysis.  You will have to understand the environment and forces that are involved in the currency market as well as the psychology of other traders in the market to determine price trigger points.  This can be achieved by using a price chart.  When you have decided what and when to trade, the next step is to do everything you can do reduce your risk.  If you are able to measure your risk, you should be able to manage it most of the time.

Playing the Odds

In order to stack the odds in your favor, it is vital that you decide on an exit point for your trade.  This means that when your trade reaches this point, you will get out of the trade.  The difference between the exit point and entry point into the trade is your risk.  It is important that you accept the fact that you are taking a risk before even placing your first trade.  If you are able to accept the risk of loss and you are comfortable with it, then you can analyze your trades more thoroughly.  However, if you are finding it difficult to deal with the thought of this risk, then you should not get involved with that trade as you will be emotionally compromised and unable to trade objectively as a result.

In addition, you should choose another point and if the market reaches that point you will then move your exit point to that new point.  This second point is the price where you will break-even if the market reaches that point.  When you have protected yourself with a break-even point, you have eliminated nearly all of your risk as long as you trade at that point and the market is liquid.  Also, it is important that you know the difference between market orders, stop orders and limit orders.

The Importance of Liquidity

Liquidity is another important factor to consider when you want to manage your risk.  Essentially, liquidity means that there are enough traders in the market at the current prices to allow you to efficiently and easily place your trade.  In the currency market, all of the major currency pairs are liquid but not all brokers have a constant liquidity.  Broker liquidity is more important than currency pair liquidity and will have a greater impact on your trades.

Low Risk for Every Trade

When you are trading, your risk should only make up a small percentage of your trading funds.  Generally, a good risk percentage to have is 2% of your total trading funds.  This means that if you have $10,000 in your trading account, the maximum loss for each trade should be no greater than $200.  This will allow you to experience 50 losing trades before you completely deplete your account – an improbable situation.

Please feel free to comment on this simple guide to forex risk management. What do you feel is the best approach to trading forex? Do you agree with the maximum trades listed above?