Risk Manager
Risk management is an essential yet often underestimated topic in trading, with more than 70% of traders losing money due to poor risk management rather than lack of experience or trading strategy. As the saying goes, “cut your losses while the gains will eventually come on their own.” Strict risk management is vital for becoming a successful and professional trader.
The Forex market is the world’s largest financial market, with an average daily traded volume of over 5 trillion USD. Here, banks, financial establishments, asset management companies, hedge funds, and individual traders compete and have the potential to make significant profits or losses.
Experienced traders emphasize the importance of prioritizing losses over gains. To manage risk effectively, here are some of the crucial aspects to control:
- 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
While this list is not exhaustive, it covers the main rules that traders should keep under control. Managing risk is a challenging task, which is why we have developed a Risk Manager tool that enables traders to focus on trading while delegating risk management to automated software.
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. All the key points mentioned above were taken into account in our risk manager tool so let us uncover them and describe how the risk manager can be helpful.
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.
