The forex market is arguably the best market across the globe. A lot of traders are making profits in the market, attracting several other retail traders to have a go as well. However, that may not be the case.
There’s an element of risk in forex trading, and hence requires a lot of skill to ensure you manage your money.
A risk is an event that causes capital loss, and in forex trading, there’re a lot of risk factors that any trader has to be aware of and understand how to mitigate them. Here are some of the risk factors that any forex trader should be aware of:
This is a drawdown that causes a high percentage loss of equity. It’s used in estimating the worst effect of a risk on a trader’s account.
Knowing the drawdown helps to come up with a system to protect the account as well as give it the ability to withstand the shock resulting from the maximum drawdown.
As much as most traders don’t consider initial capital as a risk element, it’s a factor that should be considered as well.
It determines the reserve capacity the account has that gives it an ability to withstand adverse trade outcomes.
Most beginners incur losses from the beginning of their trading journey. Initial capital is required to facilitate more trades.
Losses are inevitable in forex trading but can be controlled by deploying stops, but with multiple trades, losing capital can be a real danger. As a result, an account loses the ability to make new trades.
Therefore, the initial capital should be three times more than the required margin or be twice the initial margin + maximum drawdown.
The forex market requires some guts sometimes to make massive gains. As a result, high risk is put to acquire the intended reward.
The reward-risk ratio is calculated using the profit factor or merely the profit/loss ratio.
The most desirable reward-risk ratio should be at least 3:1, meaning you should always be aiming at least three pips take profit in every pip as stop loss.
Another significant risk in forex trading is the position size and represents as well the point where money management interventions are applied in mitigating the risk of a forex account.
For instance, if too much capital is risked in one trade, and multiple losses occur, an account can be negatively impacted.
Basically, position size is sought of direct component of risk and determines the minimum capital required for trading a particular strategy or system profitably.
Opening several Trades
Most traders believe that opening many trades on various currency pairs is more profitable. However, the truth is that several trades are a risk, especially when losing money on most of them.
It’s similar to losing consecutive trades in one market. Therefore, you should limit the number of open trades.
Most traders will tell you the reason for joining the market is the high leverage offered. Leverage is meant to bolster the trading positions to increase the gain.
However, the only problem is that in case of a loss, then the loss as well is magnified. Moreover, it magnifies several other risk factors.
Therefore, the way to mitigate the risk factor in the leverage is by reducing it, especially by regulators like the case in the US, where the maximum leverage is 50:1.
Poor Exit Strategies
As the phrase hints itself: an exit strategy in forex trading is a method by which investors and entrepreneurs, especially the ones investing substantial sums of bucks in startup firms, transfer their business ownership to a third party company or individual, or by which they recoup the money spent in the business.
Some of the well-known exit strategies include getting acquired by another firm, equity sale, and an employee or management buyout. Exit strategies help capture the unrealized profits, or they limit/prevent capital loss.
They are executed usually with the take profit, Trailing Stop, and a Protective Stop. Either way, the exit stops are not supposed to be too loose or even tight.
The protect stop shields a trader against losses and should not be adjusted once it’s set. It can be placed either using a technical stop or the hard money stop.
On the other hand, a trailing stop is a profit protection stop safeguarding the already made (but unrealized) profits.