|Risk and Money management in forex|
What is risk and money management in forex? trading means the exchange of goods or services between two parties. So if you need gas for your car, you have to pay for it, therefore, you actually trade money for gas. In ancient times, and still in some societies today, transactions take place in the form of exchange of goods for goods. The transaction can even be done in such a way that one person repairs the window of another person's house and receives a basket full of apples in return. This is a simple and practical example of a transaction. Reducing the risk of these transactions is very simple.
To reduce the risk, the first person can ask the second person to show him the apples to make sure they are healthy. Risk and money management in forex is much more difficult than simple exchanges like the example above. This article will discuss risk and money management in forex.
Currently, with the advent of the Internet, the speed of transactions has increased and the risks are out of control. In fact, the speed of trading, the sense of instant gratification and the rush to profit in less than 60 seconds can make you think you are inside a casino, which is why many traders lose their assets. Therefore, many traders consider online trading as gambling rather than a profitable career.
Trading in financial markets is not gambling. The difference between gambling and trading is in risk management methods. In other words, you have control over your risk when trading but there is no control in gambling. Even a game like poker can be played with the mindset of a trader or a gambler. Usually, these two ways of thinking bring different results.
Strategies for determining trading volume
In the Martingale strategy, after each loss, the trader doubles the size of the next trade hoping that the chain of losses will be broken somewhere and a significant profit will be obtained. In this method, all previous losses are compensated with just one transaction.
In the Anti-Martingale method, after each loss, the volume of the next trade is halved, but in case of a win, the volume of the next trade is doubled. In this method, in the case of consecutive wins, a significant profit is obtained. It is clear that for online traders, the second strategy is a more suitable strategy, because its risk is lower.
Check out the possibilities
The first rule of risk management in forex is to check your probability of winning. For this, you should use technical analysis and fundamental analysis. You must be aware of the dynamics of the asset you are trading and know what factors cause price movement in this market.
Once the decision to trade is made, the next important step is what approach you take to risk and capital management in forex. Remember, if you can measure risk, you can manage it.
When considering possibilities, it is important to consider exit levels. The distance of your exit level from where you entered the market indicates your risk. Before you make any trades, you must accept that you may lose the capital at risk.
If you are okay with this, you can do this trade. If this amount of loss is too much for you, you should not carry on, because if you do this trade, you will surely lose your focus.
Since the other end of the trade may lead to profit, you should also set another level to exit the market. At the second level, the price reaches a point where the trade breaks even. In fact, by maintaining this level, the risk of the transaction reaches zero. However, it is assumed that the market in which you trade has a lot of liquidity and transactions are done in real time.
The next determining factor in risk management in forex is liquidity. High liquidity means that there are enough sellers and buyers to accept your trade at any given moment. In forex market, at least when trading major currency pairs, there is no liquidity problem. The volume of forex transactions even reaches 5 trillion US dollars per day.
However, the liquidity available in all brokers and currency pairs is not the same. In fact, it is the liquidity of the broker that impresses you. Unless you do your transactions directly through banks, you will need a broker to trade in the forex market.
There are also risks related to choosing a broker. Always try to choose brokers that are known and well regulated. In this case, there will be no worries about the liquidity offered by the forex broker.
Risk of each trade
Another aspect of risk and money management in forex is determined by the amount of your capital. The capital you risk in each trade should be a small percentage of your total capital. It is better to start with 2%. For example, if your capital is 5000 USD, the maximum amount you should risk per trade is 2% of this amount, so you should not lose more than 100 USD per trade.
This means that you will only lose your entire capital if you lose 50 trades in a row, which is very unlikely if you trade wisely and use reliable strategies.
How to measure risk? The risk measurement in each transaction is done by the price chart. The distance between the entry price and the stop loss price indicates the potential loss of a trade. For example, if you have $5,000 capital, you should not allow the gap between these two values to be more than 2% of your capital.
Suppose the volume unit of your transactions is a mini-lot. If a pip in a mini-lot is roughly equal to $1, and your entry distance and loss limit is 50 pips, then you are risking $50 per trade per lot. You can trade between 1 and 2 lots and still keep your risk in the range of 50 to 100 dollars. Also, you should not trade more than 3 mini-lots, because then the 2% rule is violated.
The next factor that multiplies the risk is leverage. When using leverage, instead of using only their capital, traders trade using the money provided by the bank or forex broker. The forex spot market is where leverage is provided.
Using leverage, it is possible to trade $100,000 with only $1,000 in hand, in which case the leverage is 1:100. Each pip of loss when using 1:100 leverage is equal to $10. So if you trade 10 mini lots and your loss is 50 pips, your loss will actually be $500, not $50.
However, one of the advantages of trading in the spot market is the use of high leverage. This high leverage is one of the advantages of high liquidity in this market. This means that compared to other markets, it is easy to close any trade at any time in Forex. Of course, leverage is a double-edged sword. If you profit from your trade while using leverage, your profit will be multiplied and if you lose, your loss will be multiplied.
Among all the factors affecting the management of risk and capital in Forex, the risk that is most difficult to manage are the risks that arise from the wrong habits of traders. Every trader must take responsibility for his decisions.
Loss is an inseparable part of trading, so the trader must accept it. Loss does not mean failure. Usually, losing traders think that the market will soon change. This mindset is fine when the market actually turns, but it only leads to more losses when it doesn't.
The best way to deal with this type of risk is to accept the loss and cut the losses as soon as possible. When arrogance replaces logic in your trading, there is no doubt that you will become a victim of your own misconduct in the financial markets.
The best way to properly orient trades is to use trading journals. This journal contains information such as the reason for entering and exiting a transaction, as well as the success rate of each transaction. In other words, by reading this journal, you can measure the validity of your strategy and find out whether this strategy can benefit you or not.
Control your emotions
One of the factors that always causes traders to suffer losses in the financial markets are emotions such as greed, fear, happiness and excitement. Controlling your emotions while trading can be the difference between success and failure. Your state of mind has a significant impact on the decisions you make, especially if you are a novice trader.
In order to be able to control your emotions when trading in the financial markets, use the following four strategies:
- Set personal rules for yourself and follow them in all situations
- Trade when the market conditions are right
- Reduce your trading volume
- Take advantage of the trading program and trading journal
- Try to trade in your calmest state of mind
Risk is an inseparable factor of trading, but it can be controlled by managing risk and capital in forex. Never ignore the risk that leverage and liquidity bring in the market. By developing correct trading habits in yourself, try to organize your transactions and accept only the risk that will ultimately lead to profit.
Written by: Mohsen Mohseni (Aron Groups).