What Is Risk Management In Forex?
Ever seen someone bet all their chips at a poker game, although they do not have a winning hand, but they do it anyway? Some of you maybe, but most of you not. And you’re probably thinking ‘why on earth would anyone do such an irrational thing to themselves?’… Well, how about we ask ourselves the same question.
That is correct, how about we ask ourselves why it is worth risking so much without being certain, and even if we were certain (which is not a thing in the live markets because the market is the market and it does as it pleases when it pleases) but let us say it would do what you wanted it to do, why then would you still risk more than you can or rather should be? – let me tell you why.
It’s because of greed and a certain level of pride, in the sense that you probably feel like the best poker player in the room but as they say, if you don’t know who the joker at the table is, then you’re probably the joker.
You would be kidding yourself to think that you could know with undeniable certainty that the markets would go in a certain direction at a certain time because the market is about probabilities. Weighing the probable against the possible.
Defining risk management
‘Risk management is the identification, evaluation, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability or impact of unfortunate events or to maximize the realization of opportunities.’ – Wikipedia
Now to make that definition a little simpler for all people to understand. Risk Management is the ability to identify and contain the downside of an investment or exchange to lose the least amount possible, with an opportunity to gain greatly.
Now, this sounds fantastic however it isn’t so fantastic for the Forex trader who is impatient, greedy and only sees money as the prize and not the skill you’ll acquire for a lifetime, in the beginning when they start their journey. Simply because it means you’ll definitely be tested and have to grow in patience as well ask discipline, no matter how good a trade may look.
Risk management for the Forex trader means setting a percentage value of how much you are allowed to risk of your principle.
A lot of seasoned traders’ average between 3-5% risk of their total principle, and that may sound like peanuts because your initial inclination is to think you need to risk big to earn big but in the grander scheme of things that isn’t true, it couldn’t be further from the truth! Risk to reward is a fascinating concept, especially when you using the 8th wonder of the world…COMPOUND INTEREST!
How much should you risk?
As a beginner the average risk percentage should be between 1 and 3% of your principle. Now for the trader who is trading at $100 account, he or she are probably thinking I’m crazy because then they would never achieve financial freedom or whatever they are setting out to achieve, which I wouldn’t blame them for thinking that way, however, what is worse – growing slowly or dying never having even taken hold of the opportunities available??
You’ve got to ask yourself if you’re here for the long game. Because if you are, you’ll be patient and disciplined in risking a certain amount, which will tie into how you set you stop loss levels or how you trail your stops.
Look at it this way, if you have a $100 account and you risk 2% of that account strictly no matter what happens and you only win 6/10 trades in a month with an R:R (risk to reward) of 1:3, your Forex trading account would be up 36% in ONE MONTH!!!
And I am not saying every month will be a positive month but with proper risk management and psychology, you shouldn’t overtime be looking more than you make because if you follow rules that you have set for yourself, after several losses you’d take a break from the markets, meaning you’re not risking anything!
Who would have thought that being disciplined enough to stay away from the market and not chase could be considered as risk management??
I know that sounds weird and far fetched but for the sake of preserving and further growing capital, why not have that mindset towards risk management? Sometimes the best way to manage the risk is to not be in it in the first place.
I hope your risk management skills develop as you become a seasoned, consistently profitable trader!
Happy trading my fellow Traders!