Risk Management: Everything You Should Know

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Content

What is risk management in forex?
11 tips for risk management in forex
1. Control your emotions
2. Diversify your capital
3. Choose the correct position sizing
4. Limit losses on the transaction
5. Control your losses
6. Trade high liquid assets
7. Stick to the rules of three NOT
8. Work only in the direction of the trend
9. Do not try to win back
10. Start trading with minimum volumes
11. Keep a trader’s diary
Cautionary tale about Jesse Lauriston Livermore

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During trading on the stock exchange, one should remember about the risk management in forex, because the main attribute of any transactions carried out in the financial markets is a risk. Without competent, professional management of risks, it is impossible to remain in the market for a long time. To be a successful trader, you must learn to estimate the risks, balance and reduce them. Only, in this case, the capital will not only be saved but also multiplied.

What is risk management in forex?

risk management in forex is the combination of certain actions in order to reduce possible losses. Experienced traders know that it is impossible to avoid losses, but to minimize them is quite realistic.

The risk management in forex system is the main support of the trader, which allows him to increase the efficiency of trading operations while following simple rules.

11 tips for risk management in forex

Risk management in forex is the key to survival in stock trading. It’s pretty easy to understand, but extremely difficult to apply. Brokers and advertisers like to talk about how wonderful and convenient a large leverage is while keeping silent its negative sides. As a result, Forex traders come to the conclusion that they should take a big risk and chase big profits. It’s especially good to risk “big money” on a demo account, but when it comes to real trading, the situation changes dramatically. Here you need real control over the risk.

I offer you some advice on how to apply risk management in forex trading.

1. Control your emotions

To make analysis, forecast the price movement, open/close trading positions, one should have a clear head, knowledge and cold calculation.

Emotions are the enemy of the trader, so you need to get rid of them, or rather develop such a discipline in yourself when emotions will be turned off during work. The earlier the trader begins to control himself, the faster he will succeed in trading.


 risk management in forex

To get rid of emotions, you should adhere to the chosen trading system, which consists of technical and fundamental analysis. The trading system includes rules for entering the market, exiting it, setting stop orders, and necessarily a positive mathematical expectation. A clear and emotionless adherence to the rules of the trading system will lead to a deposit growth and regular profit.

2. Diversify your capital

Diversification of capital is its fragmentation into several parts. This method of managing capital allows you to insure against the risk of losing all funds at once.

One part of the deposit must be left in the reserve, the rest should be used for trading with various financial instruments. If the currency is chosen as an asset, it is better to trade several currency pairs, with non-intersecting currencies.

3. Choose the correct position sizing

A broker can call you to work with a leverage of 200:1 and double your capital in one transaction. In practice, you, most likely, will lose your capital in one transaction, if you follow this advice. What position size should you choose? The universal formula is as follows: the less, the better. The more conservative you are with the risk, the more successful. Do not be greedy, otherwise, you will lose what you have, and you will not earn anything.

4. Limit losses on the transaction

Maximum loss on the transaction should not exceed 5% of the total amount of the deposit. Experienced traders adhere to the tactic of limiting the maximum loss amount within 30% of the deposit amount.

5. Control your losses

The most common type of risk management in forex is the loss control system. It is important to know when to fix your losses. To do this, you can use Stop Loss or so-called “mental stop”.

Stop Loss an indication to the broker to close the deal when the price reaches the certain level of loss.

For example, if you buy EUR/USD at 1.08615 and set Stop Loss to 1.0798, then when the Stop Loss price is reached, the trade will automatically close without letting you lose even more in the fall.

Mental stop means that the trader independently closes the deal upon reaching a certain loss. The mental stop requires great discipline and is more suitable for professional traders. In any case, the “stop” should be located so that the losses are fixed at an acceptable level, and this level should not change under the influence of emotions.

Risk management tips

It is best to set a stop order in accordance with the technical analysis data – in the area of local extremes, support/resistance levels, and force lines. And it is necessary to pay attention to the proportions between the levels of the stop-order and the level of profit-taking – when planning the trade it is necessary to keep the ratio of potential profits and losses in the proportion of at least 3:1.

6. Trade high liquid assets

In the process of trading, it is better to give preference to highly liquid assets, which have greater volatility. The price movement of such assets is easier to predict, it is much easier to identify the right signals for entering the market on the charts of their movement. All this increases the probability of a correct forecasting of the transaction and making a profit.


Risk management tips

7. Stick to the rules of three NOT

  1. DO NOT close the deal until the goal is achieved, otherwise, you may lose the backup funds that could save you while the next drawdown.
  2. DO NOT remove the stop order, this will reduce your possible profit of a future successful transaction.
  3. DO NOT hurry to close the position before it reaches the Take Profit level, otherwise, you will reduce the future income.

8. Work only in the direction of the trend

Before opening a position, you need to make sure of the trend direction. The transaction should not contradict the trend movement.

9. Do not try to win back

Do not add to a losing trade in the hope of being able to compensate for a loss. A new order is opened exclusively in cases when the first transaction is profitable.

Do not open the next trade immediately after losing money to recoup. First of all, it is necessary to calm down emotionally.

After a series of losing trades (three in a row), it is worthwhile to suspend trading and analyze the errors that led to systematic losses.

10. Start trading with minimum volumes

To protect the initial capital, it is necessary to start trading with one contract, a minimum lot. Such tactics will make it possible to check the efficiency of the trading system before the risks increase. According to Murphy’s law, the main losses that the trading system can bring happen at the very beginning.

11. Keep a trader’s diary

A trader’s diary is a set of records that reflects the algorithm of transactions and their analysis. The keeping of the diary disciplines the trader and allows him to analyze the strategy, make the analysis of transactions, summarize the trading results and draw conclusions on the basis of all information.

It may look like:

traders-diary

Cautionary tale about Jesse Lauriston Livermore

And you should understand that risk management is really important. To prove that, I want to tell one interesting story about one of the greatest traders ever. This story is about Jesse Livermore.

Who is Jesse Lauriston Livermore?

Risk management tips

Jesse Livermore was born into a simple farmer’s family. Not wanting to connect his fate with farming, he decideв to run away from his native city. At the same time, he did not even finish school. Livermore got into the brokerage office of Webbers Boston. The owner of the office needed a quick boy who could record the stock quotes on the board and Jesse was in his place. Taking incoming quotes from New York, Jesse began to make his own predictions and write them down in a notebook. Then, on the advice of a friend, he invested five dollars in a deal and made a profit of three dollars. In such a way he related his life to working on the stock exchange.

Jesse’s success and fall

Possessing an excellent memory and addiction to mathematical calculations, Jesse managed to multiply his capital in a short time. At the age of twenty, with several thousand dollars in his pocket, he came to New York to try his hand at the real exchange. It turned out that the brokerage offices there work differently than in the province: the trades were carried out with delays and not always at the current price. As a result, he first increased his capital to 50 thousand dollars but quickly balled them out, and even found himself in debt. However, he took the first failure as a challenge, becoming more accurate in his actions and changing the style of trading.

In 1906, Livermore made several major transactions that brought him hundreds of thousands of dollars. Now, along with technical analysis, he applied the fundamental one. In particular, he succeeded in “bearish game”. Gradually, he became one of the most influential figures on the stock exchange.

Risk management forex

The peak of Livermore’s career came in 1929: Jesse became the most influential trader on the NYSE. In the same year, he earned $100 million in the largest stock exchange operation, anticipating the collapse of the stock market and speculating for the fall. Livermore was blamed for being the initiator and the main culprit of the Great Depression.

In the early 30’s, the tireless player again put all his fortune on the line and lost it. This was the beginning of the end. The subsequent attempts to return to trading lasted for several years, but it was unsuccessful. Livermore could no longer stand it. So he closed in a hotel room and shot himself.

So, don’t be greedy and always think about risks. Wish you good luck in trading!

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