Risk management is one of the essential skills to master as a Forex trader. It is key to becoming a successful trader because it helps you minimise your losses and maximise your potential gains.
If you’re new to trading, you can easily get swept up in a roller coaster of emotions shackled to unpredictable market events. Without a proper understanding of risk management, you could incur losses and panic needlessly, or make a few pips and think you’ve conquered the world.
The truth is, trading Forex like a pro isn’t only about having years of experience. It’s gaining a solid understanding of risk management. Here are 3 simple ways you can start practicing today, to manage trading risk like a pro.
1. Use the risk/reward ratio
The key to becoming a successful Forex trader is to find a realistic balance between your risks and rewards. As the saying goes, “don’t risk more than you can afford.”
The risk/reward ratio measures your potential return for a given amount of risk. If your risk/reward ratio is 1:2, you risk 1 dollar to earn 2 dollars.
Here’s how it works:
Imagine a person you hardly know asks you to lend them $10 and promises to pay you back the $10 in full in two weeks. Most people may not find this offer very tempting. First, you don’t know this person, therefore don’t trust them, and you know there’s a chance you may never see the $10 again. That’s a risk not many people would be willing to take.
However, what if that same person asks you for $10 but offers to pay you $20 in two weeks for your trouble?
Now that’s a more tempting offer. The risk of losing $10 is suddenly more appealing because it’s tied to potentially gaining $10 in profit.
In this scenario, the risk/reward ratio is 2:1 because you have the potential of doubling your initial ‘investment’. Should that same person offer you $30 for lending them $10, then your risk/reward ratio is 3:1.
2. Set a realistic take profit and stop loss
Mastering the use of take profit and stop loss is crucial to your success as a trader. A pro trader knows how to set take profit and stop loss masterfully.
You need to understand the markets and be realistic about setting limits on the losses you are willing to take and the profits you’d be happy to make.
To get a deeper understanding of how to use a stop-loss, study the main stop loss strategies, which include:
- Pin bar trading strategy stop loss placement.
- Inside bar trading strategy stop loss placement
- Countertrend price action trade setup stop loss placement.
- Trade range stop loss placement
3. Have a trading plan
A well laid-out trading plan is your map for navigating the often complex world of trading. It will include a set of guidelines or rules that apply to your trading, like your trading capital, trade entry, and trade exit levels.
Most successful traders have concrete trading plans, and if you want to be successful in trading, you’re going to need one too.
The main advantage of having a trading plan is to avoid making decisions based purely on emotions. If you’re just starting in Forex trading, all you need is a simple trading plan that clearly defines your goals, trading routine, and pre-set risk management rules.
As long as you stick to the parameters you set out in your trading plan, you’ll be able to adjust and develop it as you grow into a more seasoned trader.