The reason why many people are not sure about venturing into the forex market is the risk that one has to take as a trader. But if you are giving up on the idea of trading simply because of the risk, then you are missing out on a lot of rewarding opportunities that you can find in the forex market. Many successful forex traders are making consistent profits by following a solid strategy and focusing on risk management. In this blog, you will learn about the best ways to efficiently manage your risk in forex trading.
- Determine Your Risk Tolerance
The first thing to do for managing your risk as a forex trader is to determine your risk tolerance. When it comes to choosing a trading strategy, you may just look for the most popular and profitable strategies and pick one that suits your requirements. But you still need to modify it based on your risk tolerance. You cannot just copy the risk management strategy of another trader as the level of risk each trader can tolerate is different and you need to manage the risk based on that.
Hence, you need to devise your risk management plan based on your risk appetite. You have to set a risk/reward ratio based on the amount of profits you expect to make from trade and also the risk you are willing to take for the potential reward. You can use tools like trading calculators for estimating the outcome of a trade in advance or other aspects like margin, and also for counting the pips you want to earn from a trade.
You need to plan the exit strategy for a trade before entering it. For this, you need to decide the stop loss and take profit levels based on how much you can afford to lose and the profit target. The stop loss is a powerful tool that automatically closes a trade when the specified level of loss is realised as you set the price for exiting the position. On the other hand, a take-profit order is used to exit the winning trade at the best price level and avoid the risk of losing your gains due to a trend reversal.
- Choose A Suitable Trading Session
One attractive feature of the forex market is that it is operational 24/5. You can trade at any time from anywhere except on the weekends. The trading hours in other financial markets are not this flexible. However, you still need to decide the best time
to trade the currency pairs that you have chosen. The trading volume and liquidity are higher during major trading sessions and session overlaps. The volatility of currency pairs will also be different based on the time that you decide to trade.
You can either pick a trading session based on your time zone or you can fix your timings after considering your schedule and the currency pairs that you are watching. One thing you can do to pick a suitable trading session and decide the best time to trade is open a demo account and trade in real-time market conditions with virtual funds. You can consider MT5 for demo trading, as it comes with many advanced tools and features that will help expedite the learning process. You can easily get the app from the broker’s website. Installation doesn’t take more than a few seconds and then, you need to log in with your credentials to start demo trading. Another thing to consider for choosing the best time to trade is your trading style and strategy.
For instance, if you are a scalper, you need to trade at a time when it is suitable for scalping with enough liquidity and volatility. For those who want to execute strategies like breakout trading, you need to check the time at which breakouts are most likely to happen and decide your trading schedule based on that. Once you establish a trading routine, you need to stick to it.
- Avoid Weekend Gaps
One thing to be careful about while trading in the forex market is the weekend gap. The market closes on Friday and you cannot enter or exit trades until it reopens after the weekend. There is even a strategy to trade weekend gaps as the price will move even when the market is closed but the gap will be filled later on and the price will come back to the closing price on Friday. However, trading weekend gaps may not be the best strategy for everyone as not all gaps get filled after the weekend.
Another thing to consider when you keep the trades open for more than a day is the rollover fee or swap which is the cost of keeping a trade position open for a longer duration. But if you are a Muslim trader, this swap can be a turn-off as it is based on interest rate differential and any transaction involving an element of interest is Haram or Forbidden as per the principles of Islamic finance. The Shaira law clearly states that one should not be paying or receiving any form of riba or interest.
But Muslim traders who want to open overnight positions without worrying about swaps can do that by finding a broker offering swap-free Islamic accounts. In this account type, you can open overnight trades by paying a flat rate admin fee which is different from swap and it is perfect for Muslims who want to engage in Halal trading. Now, coming back to the weekend gaps, it would be better to avoid it unless you are ready to take the risk.
- Pay Attention To Position Sizing
Another thing to consider for managing the risk is the lot size or position size. A bigger position size means higher profit potential but also results in higher risk. The ideal risk percentage for a single trade is 2% or less. Risking anything above 2% of the account balance is not recommended as it increases your account drawdown. Thus, you need to limit the risk per trade with optimal position sizing and also be cautious about the amount of leverage you use.
If your risk appetite is low, then you should trade with mini or micro lots to minimise the risk with smaller position sizing. In this case, you can open micro accounts instead of standard accounts or sign up with a broker who allows trading in smaller-sized lots. This is especially ideal for those who want to trade with a small amount of capital. The problem with trading with smaller-sized lots is that the potential profits will also be small and this is why many traders use leverage to amplify the trade size.
However, you should be aware of the risk that comes with leverage and understand the importance of risk management. This does not mean that you should not open bigger-sized trades or avoid using leverage but just make sure that anything that you do is logical and within your risk tolerance. Because the size of your trade position ultimately determines the potential profits and risk of loss.
Final Words
To sum it up, determining your risk tolerance is the first step towards success in forex trading. Because the one who masters the art of risk management will be able to reap the rewards without losing much money in the trading process. You should never approach the risk as a threat but rather as an opportunity.
