Risk Management And Why You Need it in Forex Trading
Forex trading is, by nature, a highly volatile, high-risk activity where losses are encountered by even the most veteran traders. Nevertheless, there are some traders out there who are more likely to encounter losses compared with others, because they haven’t devised a reliable risk management strategy that effectively manages and limits risk.
What is Risk Management?
Risk management involves keeping your losses to a minimum by ensuring that you:
- Understand the risks involved in trading forex
- Thoroughly understand the market and keep up-to-date with the latest conditions
- Use market analysis techniques, such as fundamental or technical analysis (or a combination of the two)
- Understand your trading style
- Stringently follow a tried and tested trading plan and trading strategy
- Practice new strategies on a demo trading account before executing them live
- Use trading tools, such as stop loss orders, to better manage risk
Why Do you Need Risk Management?
When you’re in the midst of a difficult trade and the market suddenly takes a turn against you, a proper risk management strategy will automatically protect you from unnecessary losses. To contrast, without using any risk management tools or strategies, you will quickly become stressed, panicked or scared, which will shroud your abilities to think logically and result in you making an impulsive (and usually incorrect) decision.
Setting Stop Loss Orders
You can implement a risk management strategy by using the range of trading tools available to you, such as stop loss orders. A stop loss order is an exit point that you predetermine before entering a trade. Once you’ve studied the market and established how far you are willing to allow the price to drop, you can then set your stop loss order, which will automatically close your trade once the price drops to your predetermined specification.
A stop loss order is one of the most important risk management tools available to you as it allows you to truly limit your forex trading losses and protect your forex trading account from decreasing in value unnecessarily.
Following a Trading Plan
Another way to protect your forex trading account from unnecessary losses is by following a tried and tested trading plan. Your trading plan will ensure your approach to trading is organised, methodical and disciplined, as opposed to being spontaneous, chaotic and risky.
The world’s most established traders take a business-orientated approach to FX trading that is organised and objective. Those investors carefully follow their trading plan, thus enabling them to evaluate their progress, maintain records of their trades and achieve heightened success.
Correct forex trading risk management protects your trading account over the course of time, enabling you to trade forex on a long-term basis whilst minimising the damages incurred as a result of losses. Although losses are an inevitable part of trading and often simply cannot be avoided, they can certainly be minimised with proper risk management.