Welcome to what probably will be the most important lesson of all!
We have now covered all the basics of Forex. By now, you should be comfortable with what Forex is and what are the basic mechanics to be successful in this industry.
But what really makes a trader is his or her ability to manage the risk! Yes, you have read that right. Even with the most successful strategy out there, you will not make it if you can't apply and stick to Risk Management!
Every trader should look at their Forex career as a LONG-TERM INVESTMENT and not "get rich quick" BS as most commonly advertised on social media with rented Lamborghini & fake Rolex watches. You can get make money and increase your wealth with Forex. That is the number 1 reason we are in this business. BUT you will never become an overnight millionaire from a £500 deposit to follow someone else 'free' signals.
As you now know, in Forex you are speculating on the price changes to the currency pairs you trade to make a profit. However, in order to participate in the market, you have to invest your own money first. Whenever you enter a new position your capital is always AT RISK, therefore it is important to have a strategy in place to protect it as much as possible. This is what you can call Risk Management!
However, there is no 'perfect' solution that fits all. Every trader will have to decide on their own risk management rules based on their strategies, risk appetite, trading style and available trading capital. We will now discuss 10 aspects you should think of when deciding on your Risk Management!
1. Trading Capital
You should trade with money you can afford to lose. PERIOD. Trading is an investment opportunity that involves risk. You should never invest money that, if lost, would cause you financial difficulties!
You can now open a live account with as little as $10 with one of the best brokers out there EagleFX , however, you should always consider if your deposit gives you enough capital to withstand the losses or drawdown that you may experience when trading!
Unfortunately, we are unable to give you the exact figure of what you should start with as it will depend on what strategy and instrument you are trading. However, we can recommend the best way to figure out your starting balance:
Use a DEMO account.
Simply set up a demo account with the deposit you are thinking of using and test your strategy, lot sizes, stop losses & take profits, etc. After few weeks of testing, you will have enough data to decide whether you are happy to go live or if you need to re-evaluate any aspect of your plan!
Demo accounts are FREE to set up and RISK-FREE as use virtual funds, is there a better way to learn? Using a demo account also gives you more time to save up enough starting capital to ensure you can stick to your risk management rules and put your emotions aside!
As already discussed in the previous lessons, leverage is a tool that allows retail traders to enter the Forex market with smaller capital. Using leverage is a great way to amplify profits as it allows you to control larger positions with a fraction of your own capital (while borrowing the rest).
To control $100,000 position you will need
$10,000 with 1:10 leverage
$1,000 with 1:100 leverage
$200 with 1:500 leverage
$100 with 1:1000 leverage
The above clearly illustrates why leverage is a great tool for retail traders with limited capital (compared to other big players). However, leverage will also amplify your losses if you're in a losing position! Therefore it is important to consider leverage your broker gives you and only trade with the one you're comfortable with!
Margin rules will vary between brokers so it is important to read and understand the levels offered by your broker. Margin is often expressed as a percentage of the full amount of the position. It is 'set aside' by your broker as collateral to cover any losses on your trading account. Based on how low your margin drops you may experience Margin Calls (being unable to open new positions) or even Stop Out Calls (when your open positions are automatically closed by the broker to prevent you from going into a negative balance).
Drawdown is part of trading, as such it is another aspect you have to consider when perfecting your risk management plan. Drawdown is most often quoted as a percentage change between the highest and lowest balance on your account and it is used to measure and determine the risk of your strategy. Even with the best strategy, there will be times when you will have a losing trade (or even a losing streak, yikes!) but by monitoring and understanding your drawdown levels you can better understand how much longevity your account and strategy has. By risking less with each trade you can increase your chances of surviving the inevitable drawdowns!
5. Market Conditions
When deciding on your risk management you have to take into account market liquidity and volatility of the instruments you are going to trade.
Market liquidity is a measure of market interest (number of buyers and sellers defining the trading volume at any given time). Liquid markets reduce risks as you will be able to enter or exit your positions relatively quickly at the price you want with relatively tight spreads. On the other hand, illiquid markets will have wider spreads, fewer participants and it may not be as easy to enter/exit your position.
Market volatility is a measure of price fluctuations over a specific period. You should always consider how volatile the pair is when deciding on your lot size and stop loss. Markets are generally more volatile during certain high impact news or economic data releases. Make sure to stay on top of the news and check out the Forex economic calendar on a regular basis!
Stay tuned and join us next week to find out the 5 remaining aspects of what you should consider when creating your Risk Management!
Start Trading today with a demo account!