Rules for Good Risk Management

0
710
Risk Management

Everyone that gets into forex trading is there to make money for whatever reason. We are naturally attracted to the lifestyle that forex can enable people to have. Where the majority of new traders go wrong is risk management. Risk management can make the difference between living to trade another day or becoming the hanging man within forex trading. Risk management is a combination of multiple ideas to control your trading risk, you can have the best trading system in the world and still fail without proper risk management.

Risk management is one of the most key concepts to surviving as a forex trader. It is an easy concept to grasp for traders, but more difficult to apply.

Risk Management

Successful traders are exceptional risk managers.  You do not have to be the best analyzer or technical analyst in the market and still make money day trading with good risk and money management.

Good Entry Position 

There are 7 majors and many other forex pairs that have countless opportunities each and every day, your job is to find the best entry for them. Now while this might seem easy it is a problem that many retail traders face daily. It is common knowledge that the best times to trade are the market opening hours and the cross over hours. The London and U.S sessions are considered the best two to start with as there are just that many more traders up and ready to go.

When looking for a good entry position there are many things to consider and trading with confluence is a key factor.

When you view a chart is it, trending, ranging or consolidating?
Is the market bullish or bearish?
Is the market trading near support or resistance?
Are you trading on the right time frame or have you looked at the higher time frame to see what could potentially happen on the lower time frames.
If you trade with indicators, what are they suggesting? Asking these questions and WRITING DOWN YOUR ANSWERS, will help you become more disciplined before entering your trade.

The problem for many new traders is that they are not looking at the charts correctly. They are buying or selling on impulse moves at the market openings which unless you get lucky or have paid particular attention to the news and are prepared to get out at break even you will lose. Be patient and wait for the setups to come to you. There are many Forex pairs you can trade so being patient is key to successful trading.

Locking in your Profits

Risk Management
Don’t Let Losses Run Wild

There are various ways to do this and many traders have different views on each. Moving your stop loss to break even once it passes a certain pip range. While this is good for risk management if you haven’t timed your entry right or there is news that spikes up you can be closed out for break even only for it to run down and smash through your take profit level.

Scaling out and In –  this is a nice tactic that will do wonderful things for your profit and loss ratio. ‘Scaling out’ simply means that you close part of your position – usually 1/4 or 1/2 – once you have made some profits, and then let the rest ride to your TP. When you use scaling out it relieves so much stress and pressure, as you know that whatever happens, you already have some money in the bank and you are part of a big move if it happens. ‘Scaling In’ is the opposite and with this, you add to your position one every new major break on the trend. When using this method I would recommend keeping your stops very tight on the scaled in trade.

Position Sizing

The purpose of money management is ultimately to manage the RISK, and not necessarily the potential reward. Too many traders get caught up in how much they can make and don’t take into account what they might actually lose if they are wrong

In order for us to manage the risk on individual trades, there are a number of things we need to know in order for the calculations to be accurate. These items are listed below and are in no particular order.

  • Your Trading Capital
  • Your % risk of capital PER TRADE in value. e.g. 2% of $1 000 is $20
  • Your Stop Loss in points/PIPs. (the difference will be explained below)

Once you have this information, there is a straightforward calculation which will tell you what you should be risking per point/PIP, in value. Provided that you do not change the variables (i.e. your stop level; entry price; capital balance), you should NEVER lose more than your desired % risk in any trade taken that results in a loss. The calculation is as follows:

Position Size = Maximum Risk/Stop Loss

EG:Position Size= $200.00/50 points/pips

Position Size $4.00 per point/pip

From this example, notice that you can trade a position size, where each point/PIP carries the value of R4,00. Thus, entering a trade, at £4,00 per point/PIP, and the market moves against you and a Stop Loss is triggered, which is 50 points/PIPs, you would have lost $4,00 x 50pts = $200,00, which is exactly 2% of the capital, and exactly the £200,00 that you were prepared to risk before entering the trade

When placing your trade you must already know how much you are prepared to lose, that way if the loss does occur it is not that much of a hard pill to swallow.

Keep You Mind in Check 

When you entered the trade it rallied or melted hard and fast with what you thought was huge momentum but suddenly it reversed and hit your stop loss. The stop-loss point you picked before you entered the trade was made while your head was clear – there was no money on the line yet. If you decide to ignore that stop once you are in the trade, you’re making a decision when there’s a lot of emotion involved. This generally has a bad ending and you can endure huge losses to your account. Accept the fact you cocked up and move on.

Go back to your trading journal and see where you went wrong, was the initial stop loss too tight or placed incorrectly, was it the time of day you traded with exeptional volatility? If you are frequently getting stopped out then take a look at your strategy and try adjust your entry points or you need to be prepared to risk more per trade.

Taking a Loss will happen

What you need to realize and remember that in trading you will incur losses from time to time, not everyone can get every trade right, unless of course you only trade when in front of the computer and monitor your trades every minute they are running. Risk management is about keeping your losses small and controlled and your gains larger and controlled. If your goal is to never lose any money you’ll end up committing one of the mistakes above, like making your position sizes too small, or exit before your stop is hit.

Prepare, Plan and Execute….. Follow these guidelines and you will continue to grow your trading account.