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Top Fundamentals of Forex Risk Management

Posted on 19th February 2020
Forex Risk Management | Al-Shuaib

Introduction

The Forex market is one of the largest financial markets across the globe. The market provides investors, banks, and other financial institutions a huge potential to make large profits. The chances of losses are also not less. To minimize the possibilities of financial losses in forex trading, every investor needs to implement some forex risk management plans or strategies.

Nowadays, there are a lot of people engaged in forex trading. However, as the forex market is continuously evolving, the majority of the traders are not at a point to gain profits as expected. The traders may end up losing their money or failing to achieve profitable returns. Therefore, risk management is a factor that every trader must incorporate in their trades.

Forex Risk Management

The forex market is extremely unpredictable. Any factors, news, or events can influence the forex market with the possibilities to make huge profits or losses. Forex risk management is the execution of remedial tactics and actions that help traders to reduce the chances of losses on the downside of a trade.

Some of the top fundamentals of risk management are

1. Risk Appetite

The primary step that a trader should take in risk management is defining risk appetite for the trade. The risk appetite indicates the demand for emerging currencies, and the traders are more likely to trade in the market. The level of risk that a trader takes determines the potential profits of the particular trade. On trading, it is likely possible to lose the entire capital that you invest. So make sure that you risk only the amount that you can afford to lose.

2. Stop Loss

The usage of stop-loss is another crucial concept that must be practiced for effective risk management in forex trading. A stop-loss order is an order that can be set to close a trade when a particular price is reached. It helps the traders to prevent significant losses in the trade. The stop-losses also helps to avoid the emotional impacts in trading. Identifying where to set the stop-losses matters; the position of your stop loss will depend on your risk appetite and your trading plan. 

3. Position Size

Position sizing can be defined as setting the right amount of units to buy or sell a particular currency pair. Choosing the accurate position size, or the number of lots that you use on trade has an imperative reach in forex risk management. The right position size has the ability to protect your trading account and maximize trading opportunities. In order to choose an accurate position size, it is necessary to set stop placement, learn about the risk percentage, and assess the pip cost, lot size, and swap charges as well.

4. Leverage

Leverage is an opportunity for a trader to trade a large amount even if he owns small capital. In simple words, leverage can be defined as a borrowed capital to improve possible returns. Traders make large profits with small investments. However, the risk and chances to increase losses are higher. Therefore, leverage is a factor that has to be handled thoughtfully. The traders can choose to use leverage based on their own strategies and preferences. Until you’ve accumulated trading experience, or have a concrete trading plan that has taken the leverage numbers into account for your losses, it is better to avoid taking gigantic leverages.

5. Emotional Management

It is crucial for a trader to manage the emotions while risking the investment in any financial market. Understanding how to handle emotions while trading can determine the success of a trader. The mental and emotional state of a trader has a very notable influence on the trading decisions, mainly when new to trading. Having a quiet and patient approach is essential for successful trading. Having emotions like excitement, greed, anxiety, fear, or apathy affects the trading decisions and may lead you to unnecessary risks.

Conclusion

The most common risks that are perceived in a trade, and the most challenging risk to manage, mainly occurs because of the weak trade habits followed by the trader. Getting losses are part of the trading that any trader may encounter. So, it is important for a trader to accept losses and learn from it. A trader must learn from both profits and losses to succeed in future trades. Not only in forex, but in any investment, the capital that you invest is surely under risk. Do not take the risk of investing money that affects your survival needs.