Risk management is the most important and at the same time underestimated topic that is related to trading. This is a known fact that more than 70% of traders lose money. The reason for that is not because of lack of experience or absence of a trading strategy, but usually because of bad risk management. It is a famous proverb that you should cut your losses while the gains will eventually come on their own. Strict risk management is a vital necessity to become a successful and professional trader.
The Forex market is the biggest financial market in the world in which an average traded volume is more than 5 trillion USD every day. This is a place where banks, financial establishments, asset management companies, hedge funds, and individual traders fight against each other and have the chance to make either huge profits or equally huge losses.
As the majority of experienced traders say, you should at first care about your losses and winners are going to come after. There are multiple aspects of risk management that have to be controlled and here are examples of some of them.
- Use stop loss for every trade
- Use trailing take profit to secure your profits
- Do not risk more than you can afford to lose
- Limit your use of leverage
- Do not use grid/martingale trading
- Do not overtrade
- Control both daily and weekly results
- Stop if you have a downstreak
- Count swaps and commissions
- Close your trading terminal when you are in tilt
This is not a full list but just the main rules to keep under control. This is not an easy task that is why we have developed a Risk Manager tool that will help traders to keep the focus on trading itself and to delegate the risk management to the automated software.
Risk Management Tips
Each of the mentioned above rules has to be covered in detail to give clues why is it important and how to manage it. We have made tens of thousands of trades both manually and automatically and spent hundreds of hours purely on risk management rules and here are the key points about each of the aspects.
1. Use stop loss for every trade
A stop loss is a feature that allows protecting your trading capital from exceeding a predefined loss amount by letting you set a price at which a trade will be automatically closed. For example, if you enter a position in the market with a view that the asset’s price will rise, and for some reason, it drops and hits the stop-loss price, the trade will be closed.
A good and common rule is to set stop loss at the level that means you will risk no more than 2% of your trading capital for a single trade.
Once set, it is prohibited to move stop-loss in the direction away from the open price. The only way it could be moved is in the direction of the trade, i.e. if a buy position is opened you can move your stop-loss only higher but never lower.
2. Use trailing take profits to secure profits
If a trade goes in a pre-defined direction it is definitely a good obstacle but you should not lose your focus and forget about your floating profit.
A good way to protect profit is to define a take-profit price where the position will be closed as soon as this price will be reached. But no one knows how far the price may go and it will be disappointing to close the position at the beginning of a strong movement.
That is why in Risk manager tool there is a built-in function of trailing limit that will evaluate all the opened positions and protect the gained floating profit.
Here is an example of how an automated trailing stop looks like according to changes in the price of an asset.
3. Do not risk more than you can afford to lose
Every trader has his own amount that he can allocate for trading or investing purposes. Some are able to fund accounts with only 100 USD while others consider 50,000 USD as a suitable amount of money to trade.
But each of these must define a loss limit per the whole account defined in the currency of the account per day and per week that he will not exceed in terms of losses. Let’s say if an account size is 10,000 USD and the defined loss limit per day was 500 USD while floating PnL is equal to minus 501 USD, then all the positions should be closed.
This option should be controlled either manually or via our Risk Manager software where it is possible to define both daily and weekly loss limits. In case when the losses will be exceeded, the Risk Manager will close the trades automatically.
4. Limit your use of leverage
Leverage means an ability to open a position with borrowed funds from the broker. Therefore, leverage allows to magnify profits but at the same time to magnify the losses in a way of increasing the potential for risk.
As an example, an account with leverage of 1:30 (popular nowadays due to ESMA rules) means that on an account with $1,000, the real buying power is equal to $30,000.
In practice, it means that if the price moves in the favor of the opened position, the full benefit of opened $30,000 trade will be gained, though it is invested 30 times less. However, the opposite obstacle is true if the price moves in the opposite direction of the opened trade.
If you are a novice trader, a smart approach to forex risk management will be to limit the exposure by not using high leverage even if it is offered by a broker. Think about using leverage only when you have a complete understanding of the potential losses. In this case, your account will not suffer from major losses.
5. Do not use grid/martingale trading
When a trader does not use stop-losses and it becomes psychologically hard to close the big losing trade, he may start to average the position, i.e. use grid trading.
Using averaging is a deadly practice that always leads to the loss of funds. It’s expected value is negative and every single grid faces a huge problem when a trend goes against the opened positions. This practice is also accompanied by the high leverage that is used to open new positions so the trading capital can be washed out very quickly.
Copy-trading services like Myfxbook have a pre-check of trading activity on the copied accounts and grid trading is strictly prohibited there. All similar services and trading strategy guides recommend avoiding using it for the purpose of saving capital.
In our Risk Manager software, we implemented the protection against grid trading. During the setup, the trader has to define how many positions in one direction could be opened and from now on the tool will automatically close positions that exceed the predefined number.
Here is an example of how grid trading looks like and that is the trading style that should be definitely avoided.
6. Do not overtrade
It is a known fact that a bigger number of trades lead to loss of concentration. A trader may stop keeping his risks under control, violate the strategy rules, trade on instruments that are not suitable, etc.
An experience when a trader starts to feel that he is overtrading comes with years and is highly valued. But a novice trader can not define when he has exceeded the comfortable for his personality trades threshold and that is why does not know when to stop.
In Risk Manager, there is a built-in function that calculates the number of open trades and trades that have been executed during the day. If the number of trades surpasses the limit, the software will close the positions.
7. Check daily and weekly results
It is a good practice when a trader controls the daily result and monitors his trading activity. But real professionals also tend to keep track of trades during the whole week. If you had a bad day and lost more than expected you can not forget about it and repeat the same losing practice the next day.
There might be something negative happening either with the trading strategy or with the instrument that is a trading strategy applied to. And the trader should not lose his focus on not losing more than expected during volatile times.
For example, if a trader had a good Monday – Wednesday period and the rest of two trading days start turning into the negative areas, then it is definitely a signal to stop the trading activity. Risk Manager has control of weekly results and if a trader’s losses exceed the predefined limits, then all the newly opened positions will be automatically closed.
8. Stop if you have a downstreak
During daily trading activity when even tens of trades may be executed it is very hard to control when you are facing a series of losses called downstreaks. They usually occur when a trader loses his focus and does not notice the change in market behavior.
Downstreak may also lead to a tilt – a word that is familiar to poker players when a player starts to enter on every dealing rate even with two bad starting cards.
In poker, the only way to avoid it is to control yourself but in trading, it is possible to use such tools as Risk Manager where the function that controls losses in a row is built-in. It automatically closes the trades when you fall into a downstreak so you will keep in line with your predefined risk parameters.
9. Count swaps and commissions
During the trading activity, it is important not only to calculate the profits from a single trade. Traders tend to forget about the fees that are applied to trades. TradingKit has developed a Swap Indicator that allows not only to monitor swaps but as well to earn on them.
In the article about swing trading, it is mentioned that swaps may be costly, especially on instruments like exotic trading pairs where one of the currencies is emitted by the country with a high-interest rate.
Commissions are also a key point that no one should forget, especially the ones that use day trading strategy and make tens of trades per day. Brokers from time to time change commissions that is why it is obligatory to monitor them.
In Risk Manager swaps and commissions are taken into account during the calculations of all the mentioned previously checks so there is no need to worry about some costs that might have been missed.
10. Close your trading terminal when you are in a tilt
When facing with one of the mentioned above cases, there comes a natural feeling to fight off the losses. Traders start a real battle against the market and want to prove that they are right and their vision is correct.
It usually leads to an exceeded number of losses an unaffordable amount of lost money. The trader has to gain years of experience before he starts feeling that the tilt is starting and stop trading before some disaster happens.
In Risk Manager, there was implemented a feature of the automated close of the terminal so when any of predefined risk setups has been violated, the software will close the terminal either immediately or within a defined number of seconds.