Risk management is simply a collection of ideas offering downside protection to investors from losing all of their money and it is also an essential part of their trading strategy that’s why it’s not enough to just have the best forex trading system; you should also have a solid forex risk management plan in place because without it you could lose everything. This is one of the most ignored areas in trading. Learning how to manage risk (potential losses) is important in order to make money.
Risk management can be minimizing your trade lot size, hedging, trading only within certain hours or days and recognizing when to take losses but many investors fail to implement these measures and most likely not to get right into trading. One common mistake of such investors is they’re making risky investments using leverage and putting big amount of money despite knowing that they can lose everything in just a snap.
CUTTING YOUR LOSSES
The objective of this is not to avoid losses but to minimize losses. One thing that separates successful investors from the rest is that they know when to cut their losses on trades before it gets out of hand. This can be done with a hard stop or also known as stop-loss order or a stop order. The alternative to a hard stop is a mental stop where you psychologically decide to limit the drawdown, you’re willing to take on a trade.
Hard stop or Stop-loss order – It is used to automatically exit a position and take a loss when a stock reaches a certain level.
Mental stop – is when the order is not placed to exit a trade for you, instead leaving the position open with no offsetting order to control your loss
Drawdown – is a peak-to-trough decline during a specific period for an investment or trading account.
DETERMINING YOUR LOT SIZE
Determining your lot size is a key part of risk management because it means keeping your risk per trade as low as possible. Even if you have the best trading strategy if your trade size is too small or too big, you’ll either take on too much or too little risk. Using a high leverage with a small investment is risky and it can evaporate your trading account quickly. Finding the best lot size based on your current trading account assets will help you determine the amount you would like to risk. Lot size affects and indicates the amount of risk you’re taking. This directly impacts how much a market move affects your account.
KEEPING YOUR OVERALL EXPOSURE LIMITED
Exposure refers to the amount of money that can potentially be lost on an investment thus it is tied to risk that’s why it is an important part of managing risk that every investor should know. You can reduce your risk and increase your prospect for long-term success by keeping your overall exposure limited. Opening multiple lots of currency pairs could also put you at risk. Remember that, having a high exposure means increasing your overall risk.