Trading forex to make money is a primary objective for investors and achieving that goal is easier when focusing on strategies that mitigate risks, protect positions, and reduce the severity of losses. Being proactive with risk management and knowing when to exit the market can be just as important as a streak of successful trades.
When buying and selling foreign currency, abiding by the following rules will enable you to make moves at the right time but always with a consideration about your account status and protecting your money in the long term. For both new investors and seasoned professionals, forex risk management should be part of a daily strategy.
Follow a 1%-2% rule
It can be tempting to make large trades with a significant portion of your initial budget when you start out, but this can quickly lead to failure if you make a few wrong moves. Traders generally adhere to the ‘1% rule’ where they only open a position with a single percentage of the money in their accounts.
This means that if you have $5,000 capital available, you would only open a position for a currency pair, or stock, with $50. Some traders opt for a 2% restriction instead to give themselves more leeway when entering the market, but this is considered to be the maximum limit. By only using a small amount in your account, you can continue trading even after a streak of losses.
Getting to grips with all of the instruments that are available is in your best interests when you start trading. One particularly important tool is the ‘stop-loss’. A stop-loss order allows you to set a predefined price for a position to close automatically. This is important as it will limit losses when the market goes against you.
How you wield stop-losses will depend on your trading plan, but again, investors often use them to ensure that only a maximum of 2% of their trading balance is compromised for each position. There are several other types of ‘stops’, including equity, volatility, chart and margin. Being able to use these effectively is important for risk management.
Be careful with leverage
Forex traders use leverage to make larger trades with less capital with the aim of amplifying gains. However, leverage can also increase losses and put your account at risk if it is not used judiciously. Risk tolerance and level of exposure are, therefore, something that you need to think about for each trade.
While traders agree that the trading on margin is a net positive, you should be cautious when starting out. Try to build your portfolio slowly and only use leverage when it makes sense. Actively managing these risks and exercising self-discipline in tough moments can really make a difference.
Use a reputable broker when trading CFDs
Contracts for difference (CFDs) are popular instruments in forex as they allow traders to speculate on the prices of currency using leverage. Because trades on margin are inherently riskier due to the capital being borrowed, it is important that you prioritize CFD trader safety and partner with a reputable broker.
Fortunately, there are sites that compare all of the brokers available so that you can select the best one. This is something that you should be doing generally anyway before trading forex. Finding a broker that you can trust will give you the peace of mind that your deposits and account are always safe.
Diversify your portfolio
Rule 101 for risk management is diversification. It is common sense to make a range of different investments rather than putting all of your money into one trade or currency pair. By diversifying, you will be protecting yourself if a market goes against you. In forex, this might involve splitting your money and using smaller lot sizes for ‘correlated’ currency pairs. Being aware of correlation and how GBP, USD, EUR and other popular currencies are linked can improve the quality of your trades.
Be realistic and have a plan
Profits are the name of the game, but you need to be realistic about your gains, both in the short term and long term. You can calculate expected returns from trades by taking a closer look at the fundamentals of currencies such as historical breakouts and support/resistance levels. New traders should be using research and analysis and combining it with realistic goals to set out a plan that can deliver sustainable, steady gains.
Trading forex, stocks and other assets is not easy then and you will need to consider risks carefully to be successful. By taking risk management seriously when you start out, it will soon become second nature and you will give yourself a solid foundation to build from as you look to diversify and make more trades.