Welcome back to our educational blog! We hope you have enjoyed Spring Bank Holiday (if you're in the UK) and are ready for the summer! We certainly are getting closer to bringing you some of the greatest features and a new platform!
Let's dive right back into our lesson about understanding the importance of Risk Management!
6. Risk to Reward Ratio (RRR) & Maximum risk per trade
If you're trading using a stop loss and take profit levels you can increase your chances of being a profitable trader by using an appropriate risk-to-reward ratio. These will vary based on your trading style, the strategy used, the timeframe you trade on, instrument traded, broker spreads, etc.
You must find RRR that works for you and don't simply follow the very common approach to have a minimum of 1:3 RRR!
What is 1:3 RRR? You are risking $1 to potentially make $3 per trade, of course, relative to your lot size you may be risking $10 to make $30, or $50 to make $150 etc.
However, there is no 'one RRR fits all' and you may as well use 0.8:1 RRR if your trading strategy (for example scalping on M1 timeframe) generates better returns!
You should also always aim to have sustainable exposure with all your trades. Have a clearly defined max risk per trade in % and stick to it. You should never risk more than 2% or 3% of your account per trade or pair! You're more likely to survive and recover from a losing streak when only risking 2% per trade than when you're risking 10% per trade. Remember it is a long term investment and you will experience losing trades!
7. Stop Loss (SL), Take Profit (TP) or Trailing Stop Loss (TSL)
Now that you know what your RRR is, you can implement that when deciding on your Stop Loss and Take Profit Levels. Your entry should always be determined by the market analysis and in line with your strategy.
You should never gamble or rush into a new position if you're not 100% happy with what you can see on the chart! Trading with SL and TP is the easiest way to manage your risk! Once you've calculated the pip value for your pair you then follow your plan and set the SL at the maximum amount you're willing to lose (if the trade hits SL) and TP at your potential return (if the trade hits TP). However, you can always decide to use Trailing Stop Loss to protect (and at least breakeven if the trade went in your favour and then reversed, which may happen!) or increase your profits! TSL is an SL order that will automatically trail the market at the value chosen by you. TSL comes in handy when you are unable to move SL manually!
8. Trading News
Another important aspect of managing your risk relates to trading (or NOT trading) during an economic news release! To be a successful trader you must be aware of the high impact news that is scheduled in the week ahead, there are plenty of FREE economic calendars that you can use and make sure you are prepared for what's ahead. When trading high impact news you may be exposed to gap risk which refers to a sudden price jump (from one level to another) with no tradable prices in between! These can range from anywhere between 20 to 80 pips (or more). Since SL orders are subject to gap risks your order may not be executed at the rate you specified (also referred to as slippage) and cause much bigger losses than you were ready to risk!
9. Weekend Positions
You should also consider whether you want to keep your trades open over the weekend! Forex markets close on Friday evening, however, any unexpected news or events (such as terrorism, natural disasters, political turbulence, etc.) will impact the price levels you see when they open on Sunday! This is often referred to as weekend gap risk and can also cause significant losses beyond your SL levels. The safest approach is not to keep any open positions over the weekend (unless you are a long-term trader and intend to keep your positions open for weeks or even months).
10. Trading Journal
The last aspect of effective Risk Management that we are going to discuss is keeping a trading journal! Yes, if you want to become more profitable, you have to keep the details of all your trades! Especially the losing ones!
We all love winning trades but let's face it - losses are part of the game. However, if you study and better understand them, you will be in a better position next time you see a similar set-up! By at least trying to better understand what happened and why you have lost you may come up with a fresh approach to the set-up! Maybe you will change your RRR or adjust your SL/TP or even skip the trade whatsoever protecting the capital in full! Remember why you are trading - to make money! As such, you should never force a trade! Especially if you don't see a valid set-up! Forex is open 24 hours a day, 5 days a week and is full of opportunities to enter, make sure you find the right ones for you!
We hope you've enjoyed our Top Ten aspects of Risk Management and are ready for what's to come in the coming weeks!
First, we will review different types of market analysis in weekly segments. And after that, we will move onto discussing the importance and main elements of a Trading Plan! Stay tuned!