Managing Risk

Importance of Risk Management

Risk management is crucial to the long term success of any forex metatrader. It is very important to treat your trading account like you would any other business. Trading is not a game, it's real money and it's very easy to lose it if you don't know what you are doing. Risk management can make or break a good trading system.

 

What Is Risk Management?

Risk management is an essential part of effective investing.  It separates investors from gamblers.   In its simplest form, it is understanding which risks are likely to be profitable and which are not. In investment lingo this is described as “limiting one’s risk exposure.”  Some risk is necessary to earn a profit, too much will empty your account.  You need to find a profitable balance.

Below are three risk management techniques that can help create this balance.

 

Stop Loss Order

A stop loss order, or sometimes referred to as a conditional placement, can be broken into different categories based on a traders requirements. The various types include:

  • Sell Stop Loss Order
  • Stop Limit Order
  • Buy Stop Loss Order
  • Trailing Stop Loss
  • Trailing Stop Limit Order
  • Bracket Order

Setting adequate stop loss orders in Forex is extremely important. As it is a leveraged product, the fluctuations in pricing can be quite significant on a daily basis. Recent economic and monetary policy changes have spurred a new wave of volatility in the markets and will continue to cause uncertainty. Stop Loss orders are a fantastic way to manage appropriate risk and keep within your own personal trading guidelines and rules.

For more information on Stop Loss, view the article 'The Importance of Stop Loss in Trading' in our Forex Blog.

 

Determining Trading Risk

An investor can determine the exact risk of a given trade by using a risk-reward ratio. While novices tend to only focus on the potential gains, potentially losses play an equally important role. The risk-reward ratio helps the trader to focus on both aspects of each trade. What is a good risk-reward ratio? While 1:2 ratio is acceptable number a better ratio is 1:3 or 1:4.  A 1:1 or 2:1 risk-reward ratio is unacceptably risky.

 

Keeping The Profits

A third and very rewarding risk management tool is to regularly remove any profits from a winning trade. This automatically reduces your risk exposure and forces you to keep your gains.

Implementing effective risk management strategies is the difference between investing and gambling.  Being disciplined about this will dramatically increase your chances of long term and profitable forex trading.

 

Risk : Reward Ratio

The risk:reward ratio is used to compare expected returns of an investment versus the amount of risk associated with those returns. It is calculated by dividing the amount of profit expected when the position closes (reward) by the amount the trader stands to lose if price moves in an unexpected direction (risk).