Effective Forex Trading Risk Management Strategies Every Trader Should Beware of

28 November 2020 | Updated: 28 November 2020

Risk management is a crucial topic when it comes to forex trading. Every forex trader wants to minimize losses and maximize profits from each trade.

Many traders lose money not because they lack knowledge or have no experience in the market, but due to poor risk management.

The right risk management strategy is critical if you want to be a successful trader. Read along to understand some tips to ease your trading experience.

Understand the Forex Market
The foreign trading market comprises currencies from across the world. It is driven by the forces of demand and supply. Forex MetaTrader trading operates like any other trade where you get an asset in exchange for currency. The market price determines how much currency should have to buy a different currency. The initial currency that appears in a foreign exchange pair quotation is known as the base currency.
The second currency, on the other hand, is referred to as the quote currency. The price that appears on a chart is always the quote currency. It illustrates the amount of quote currency you will have to spend to purchase a single component of the base currency.

For instance, if the currency exchange rate for the GBP/USD is 1.25000, then you will need $1.25 to purchase $1. There are three types of foreign exchange markets, as we shall see below.

• Spot market. This is where the real currency pair exchange occurs at the same point, where the trade is executed, that is on the spot.

• Futures market. In this case, a contract is made to sell or buy a specific currency amount at a certain date and price in the future. A futures contract is usually legally binding.

• Forward market. Here, a contract is made to sell or buy a specific currency amount at a particular price at an agreed-upon date. This can take place either in the future or within a set of future dates.

Risk Management Strategies to Consider
• Use a Stop Loss
A stop-loss tool is a crucial tool that allows traders to secure their trades from sudden market fluctuation. Traders can set a pre-determined price at which their trades will close automatically.

Let us assume a trader opens a position in the forex MetaTrader market and are certain that the asset will increase in value. Instead, the asset decreases in value due to various reasons. A trader in this position should not worry because once the asset hits their stop-loss price the trade closes automatically to avert massive losses.

It is worth mentioning that the stop loss strategy is not a guarantee. Sometimes when the market becomes unpredictable and displays price gaps. In this case, the stop loss may not be enforced at the pre-set level. Instead, it will be initiated at a later time when the price hits that level. This occurrence is referred to as slippage.

Traders should ensure the stop loss is at a level where their loss will not be over 2% of their trading balance in any trade. When you activate your stop-loss avoid increasing the loss limit. There are various stops in forex trading. Each trader places the stop loss depending on their experience and personality. Here are the common stops you should know.

• Volatility stop
• Equity stop
• Margin stop
• Chart stop or technical analysis
Utilize a Take Profit to Shield Your Profits
A take profit is similar to a stop loss. Unlike the stop loss that closes trades automatically to prevent more losses, a take profit closes trades when they reach a specific profit level. Defining your expectations for each trade allows you to set a profit goal and ensures that you determine the trade’s suitable risk level.

Consider the profit levels you are targeting and the level of loss you can withstand. Doing so helps you remain disciplined and consider reward versus risk while trading.

Finally
An effective risk management strategy allows you to regulate your losses and profits. Research widely and try different strategies on a demo account to establish what best fits your needs.

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Azeez Mustapha

Azeez Mustapha is a trading professional, currency analyst, signals strategist, and funds manager with over ten years of experience within the financial field. As a blogger and finance author, he helps investors understand complex financial concepts, improve their investing skills, and learn how to manage their money.