This article looks at some risk management principles that should be included in your foreign currency exchange trading plan.
The one reason why so many beginners in the foreign currency exchange market fail is that they do not take the time to implement a suitable trading plan. When you implement a trading plan, you must ensure that it contains a solid risk management section or you will be at risk of losing a great deal.
Foreign Currency Exchange Position Sizing
Position sizing is the determination of the size of the position you intend taking on your trade. There are several ways in which you can size your positions. Some of these methods are fairly simple and others are extremely complex. Some traders use a method of sizing by determining the level of risk they are prepared to take on a position relative to the total value of their portfolio.
Others are more simplistic in their methods and simply trade a particular lot size. They continue with this method until such time as the standard sizing method becomes too small or too big for their portfolio. This is dependent upon the success of their trading career.
Some traders size their positions based on how profitable they believe the trade could be. They may enter a larger trade if they believe the success level of a particular trade is particularly high.
Some traders make the decision to decrease the size of their positions or even remove it completely if they believe that the risk to reward ratio is too high. They may feel that the reward is too low for the high risk level.
Limit Your Losses
The second most important consideration you have to make regarding risk management is to manage risks once you have entered a trade. You can make use of stop-loss orders once you have entered the trade. You should include stop loss orders as part of your trading plan and set it as soon as you have entered your trades.
There are traders who choose to keep an eye on their positions rather than making use of stop loss orders. This is done to avoid whipsaws or their forex brokers triggering their stops. This method should not be used by beginners as it could lead you to lose trading discipline.
The management of losses is of the utmost importance to you as a trader, but you should also be able to recognise when you have a profitable trade and allow it to continue. To do this you can make use of a trailing stop to protect those profits if your position is moving in the right direction. You could make the decision to move your stop to a point of breakeven once your trade has achieved 100 pips at least. Moving your stop further toward that of the current spot rate will offer your profits more protection. Once that trade has gone as far as you think it will go, based on certain indicators, you should close your trade immediately.
These are a few factors that should appear in your risk management plan. You should also be careful of the leverage you make use of. You can benefit from leverage if you are fully aware of the risks involved with using it.