Risk Management in Forex Trading

Trading Guide

14 Aug 2021

Risk Management in Forex Trading

With a high rate of volatility in the FX market, profits and losses go hand in hand. But before jumping into the sea of forex trading, one must be aware of all the risks associated with it and how to deal with them to minimize loss.

What is risk management in forex trading?

In simple words, forex risk management is a set of actions that prevent any potential negative impact of the forex trade. It helps in mitigating the losses that occur due to exchange rate fluctuations and other market factors. So, if you want to make your trading procedures safer and more controlled, it is absolutely necessary for you to have an effective forex risk management strategy In this article, we will discuss everything you need to know about forex risk management to help make your trading experience more profitable and stress-free!

Potential Risks of Forex Trading

Market Risk – The risk of the financial market behaving differently than you expected.
Currency Risk – The risk associated with fluctuations of the currency prices which makes the foreign assets more or less expensive.
Leverage Risk – When the initial outlay is much smaller than the value of the FX trade, most forex traders use leverage to open trades. This may lead to losing more money than was deposited in the account initially.
Interest Rate Risk – The risk related to sudden fluctuations in the interest rates of an economy. The changes in the interest rates affect FX prices as the rate of spending and investing will also change simultaneously.
Liquidity Risk – If you can’t buy or sell an asset quickly enough to prevent a loss, it is known as liquidity risk. The periods of illiquidity can cause a delay in opening or closing a trade, meaning that the trade is not executed at the expected price which can cause loss or low profit.
Risk of Ruin – The risk of you running out of the capital needed to carry out trade.

Now, that you are aware of the several kinds of potential risks related to the forex trade, it’s time to discuss how to prevent them through proper risk management. Remember, many traders tend to lose money in the financial market – not due to the lack of experience or knowledge but due to poor risk management skills.

Tips to Manage Risks in Forex Trading

Only trade money you are willing to lose –This is the fundamental rule of trading that is often broken, especially by new forex traders. But this only puts them in an unnecessary position of vulnerability. The forex market is highly volatile, and it is very much possible that one may lose the entire trading capital. Moreover, trading with funds you cannot afford to lose will put extra emotional stress and pressure on you which may increase the chances of you making wrong decisions.

A good rule of thumb is to only risk between 1 and 3% of your account balance per trade.

Understand the forex market – Whether you are a beginner or an experienced trader, it’s always a good idea to educate yourself with the upcoming trends of trading and gain a deeper knowledge of the risks associated with the forex market. If needed, take help from the various articles, videos, and webinars available on forex trading to keep yourself informed.
Use stop loss & limit orders – Stop loss and limit orders refer to the instructions given to a broker to close a trade when the market price hits a certain level. Therefore, if the price of an asset hits the stop-loss level, the trade will stop to prevent further loss. However, there is no guarantee against slippage
Leverage – Leverage in forex allows traders to make more profits from their accounts, but it also increases the chances of losses which elevates the risk factor. That’s why we recommend you manage your use of leverage wisely.
Set a risk-reward ratio –The risk you take with your capital should be worthwhile. Therefore, you must set a risk-reward ratio to qualify the worth of your trade. It will further improve your chances of gaining better profits in the long run.

To find the ratio, compare the amount of money you’re risking on an FX trade to the potential gain. We suggest a RRR of 1:2 for scalpers and day traders and 1:3 for position traders.

Manage your emotions – As we all know, the forex market is extremely unpredictable. If you let your emotions like fear, greed, or boredom rule your decisions, it may expose you to undue risks.

It is seen that emotional traders often struggle to stick to trade rules and strategies which lead to heavy losses. Hence, we suggest you refine your trade strategies based on previous data rather than your feelings. The scope of risk management in forex trading is so large that we can go on and on. If you need more tips, connect with our team of professionals at VFM Brokers.