Risk Management in Forex
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Risk Management in Forex

  • writer Author
  • May 27, 2024

Forex trading demands attention during ongoing trades, while it also demands well-thought decisions, patience, and discipline to exit a trade without greed taking over your rationality. Risk management is the process of identifying, assessing, and mitigating the risk in trading. With continuous fluctuations in the forex market, it becomes necessary to master Risk management to minimize potential losses and preserve profits. It also eases your level of activity and screen time on your trades. This guide will delve into core aspects of risk management mentioning stop loss, position sizing, risk reward ratio, and many more important topics responsible for securing your funds.

Forex being the biggest trading market across the world, involves big central banks of countries, hedge funds, and financial organizations that move the global economy from one end to another only to maintain the economies of their respective nations. Forex is a highly liquid market, a safer way to invest your money for long-term and easy entry - exits. Forex market faces volatility on days when major economies announce their reports on their country’s economic performance. This causes a heavy ruckus between buyers and sellers, which leads to uncertainty in the market and the possibility of potential profits and losses.

To mitigate the risks of potential loss, traders use multiple risk management strategies and maximize their profits even in volatile markets. Risk management involves the identification of your risk appetite to further acknowledge the level of leverage and risk-reward ratio you can utilize for a safe profitable trade. 

 

Risk Appetite:

Risk Appetite or Risk threshold is a limit of the total amount a trader can allow to lose on a trade. It is the first step to take in the process of risk management leading traders to ease the determination of their allowable loss. The allowable loss is the amount, if the trader loses on a trade he/she won’t be feeling regret over the lost amount.

Risk appetite is calculated in percentage and a trader must determine the percentage he/she is willing to lose if the trade doesn’t favor their decision. Traders ideally keep 1 - 3 % as their risk threshold which helps them save their capital from total wipeout. This strategy helps traders from blowing their accounts in a few bad trades. Traders save capital through this strategy so they can trade more without losing too much. This approach aligns with the philosophy of preserving capital as the primary goal in forex trading as the key to success in forex trading is not in making more profits but rather in minimizing losses.

 

Position Sizing: 

Position sizing is the second pillar of risk management in Forex. Practicing or utilizing position sizing involves determining the number of currency units while buying or selling in trade. The determination of position size depends on the risk per trade a trader decides to take on a particular trade and the account size he/she has. 

A trader with a bigger account size remains comfortable with taking a big position size under his/her desired risk per trade, while a trader with a small account size may remain cautious of his small position size and low risk per trade. It changes from trader to trader depending on their trading capacities.

A bigger position size exposes itself to the dangers of significant losses but also opens doors for potential profits, while a smaller position size can not entertain the potential profits but saves a trader from huge losses. The key point here remains about the perfect balance that satisfies your trading approach with risk tolerance. 

A perfect balanced position sizing ensures that Orbit Global's traders don’t miss out on profitable opportunities due to undersizing nor do they expose themselves to significant losses through oversizing.

 

Leverage:

Leverage amplifies your position size through which a trader can earn leveraged profits and Orbit Global provides 200:1 leverage! Using leverage is like waving two sided sword, which contributes the same harm as benefits served. A trader can face huge losses on leveraged positions, once the market takes an unfavored move. 

In such situations, traders need to take charge of their margin. Margin is the amount of money needed to open a leveraged position in trading. This margin starts getting deducted when positions start falling from the strike price. The complete wipe-off of margin is called a margin call - an event where the trader needs to refill the margin, if he fails to do so, it leads to account closure.  
Leveraged positions can be successful if the traders implement stop-loss orders in conjunction with a proper risk-reward ratio. Leverage used responsibly with stop-loss orders and risk-reward ratio, can protect the trader’s capital and increase the chances of long-term success in trading. 

 

Stop-Loss Orders:

Stop-loss orders are used to limit losses by closing a trade automatically once the market moves against the trader. Stop loss utilizes the risk-reward ratio to close a trade automatically in both positive and negative directions. Trade gets closed in the positive direction when the market reaches a determined level set by trader for the sake of discipline, cutting the greed off. 

Stop-loss orders are extremely helpful in maintaining discipline. A disciplined approach that does not let greed and hollow hopes take over a trader’s emotions leads the trader to prevent losses and conserve more profits. 

Traders can accumulate more profits using stop loss without closing on an upward trend. Traders move their stop-loss when it reaches the upper end of the stop-loss, this method of moving stop-loss is called trailing stop-loss. Trailing Stop-loss helps traders capitalize more on trades by chasing on uptrend profits and eliminating the probability of loss. Even if the uptrend loses its momentum and switches direction to hit the stop loss, the trader would still end up with profits as the stop loss was hit too above the strike price. 

 

Risk Reward Ratio:

It is important to calculate the proper risk-reward ratio to lose less and earn more. Traders utilize 1:2, 1:3, 1:4, and 1:5 risk-reward ratios, as there is not a one-size-fits-all approach in determining the ratio. A 1:3 ratio defines that a trader can bet for one unit of trade in loss in exchange for 3 units of profit. Sign up with Orbit Global to capture higher units of profits. 

A proper risk-reward ratio when utilized for the long term, results in inflated capital in trader’s portfolio as they stop following bad trades and also highly volatile markets. 

Portfolio Diversification:

Trading or investing in different currencies can help traders grow their capital in the long term and mitigate the risks of market volatility. Trading in many currencies spreads risk and mitigates the chances of significant loss. 

In forex many currency pairs and different assets follow the same patterns during trading hours, this similarity of patterns is called correlativity. 
Traders must acknowledge the correlativity between currencies before investing in different pairs of currencies. If two currency pairs are highly correlated, it would lead to overexposure to market risks. 

It is crucial to trade or invest in low correlating currencies, as they can mitigate the risk by compensating when one currency pair does not perform well. This reduces dependency on one currency pair for profitability. 

Investing in cryptocurrencies, metals, different assets, and currencies can ensure portfolio stability and growth at the same time for the long term. When trading, traders also invest in different currency pairs to mitigate market risks and capitalize on favoring currency pairs.

Conclusion

After learning about tools like stop-loss, position sizing, risk-reward ratios, and portfolio diversification, mastering Risk management doesn't sound like an option, it becomes more necessary to learn and apply in daily trading practice. New Traders need to understand the fact that potential profits are not achievable by trading more volume but by managing to lose less in trading. Also in the benefits of new traders, we advise them to go through our Informational Content