Managing Risks in Forex Trading, or, in other words, Forex Risk Management, lets you set up a stack of rules and measures to guarantee that any unfavourable effect of a forex trade is manageable. An efficient strategy needs the right planning from the very beginning. So it’s better to start trading only when the risk management plan is in place.
Forex trading: risks
- Currency risk
Currency risk is the risk commingled with currency price fluctuation, making foreign assets more/less affordable to buy;
- Interest rate Risk
Interest rate risk is the risk related to the abrupt appreciation/depreciation of interest rates which impacts volatility. It changes impact Forex prices since the level of spending and investment across an economy will rise/fall, contingent upon the rate change direction;
- Liquidity risk
Liquidity risk is the risk you cannot buy or sell an asset swiftly enough to sidestep a loss. Notwithstanding that Forex is a highly volatile market, there can be illiquid periods. A number of factors could account for this.
- Leverage risk
Leverage risk is the risk of magnified losses during margin trading. Since the initial outlay is smaller than the Forex trade value, it is easy to form a poor assessment of exactly how much capital is at risk.
Managing Risks in Forex Trading: basics
- Defining the Forex market
The Forex market is comprised of currencies from all corners of the globe, divided into categories per their influence. As a result, forex or FX is, unsurprisingly, swayed by demand and supply forces.
- Forex trading works akin to any exchange where you are purchasing an asset using a currency – and the market price informs you of the amount of currency you need to spend to enable the buying of another.
- The Forex pair quotation is made up of two components. The first currency is the base currency, while the second currency is called the quote currency. The chart displayed price is always the quote currency – it stands for the amount of quote currency you will be spending to buy one unit of the base currency.
There are three types of FX markets:
- Spot market –
A currency pair’s physical exchange takes place at the exact point of trade settlement. In other words, ‘on the spot’.
- Forward market
The forward market is obtained when a contract is agreed to buy/sell a set amount of currency at a particular price, at a future predetermined date, or within a future date range;
- Futures market
A futures market is obtained when a contract is agreed to buy/sell a definite amount of currency at a predetermined price and future date. In contrast to forwards, a futures contract is legally binding.
Getting the hang of ‘leverage.’
Leveraged trading will concern you with forex price movement speculation with CFDs/spread bets. A small initial deposit or margin will permit you your full market exposure.
Even as leverage trading has its benefits, there are lurking disadvantages. The possibility of magnified losses is among them.
A good trading plan
A trading plan can assist in making your Forex trading more convenient by leaving you by the hand in decision making. Also, the same permits you discipline amidst pervasive volatility. The trading plan seeks answers to what, when, how, and why to trade. It helps narrow down your focus, whittling away the inessential.
Given that every trader has different goals, ideas, perspectives, and attitudes relative to his contemporaries, there’s little reason to believe you will gain much by giving up your individuality when you adopt someone else’s trading plan. If you want your trading career to develop, you ought to invest time, effort and intelligence in honing whatever rudimentary trading plan you do have. Reaching the semblance of perfection will likely take years, but – well begun is half done!
A good trading plan is also well served by a trading journal. The journal or diary will be a tool you may use to keep a record of all that’s eventful whilst you trade. You could elaborate upon a lot of details here – from entry and exit points to your psychological condition at that time.
The risk-reward ratio
For each trade, the risk you take with your capital has to be worthwhile. As a rule, you are looking for your profit to exceed the losses. Despite losses on individual trades, you intend to keep on making money in the long run. Per your forex trading plan, you ought to set our risk-reward ratio to quantify precisely how much a trade is worth.
Stops and limits
- Given the remarkable volatility of the Forex market, it becomes rather important to determine your trade’s entry and exit points prior to you open your position.
- Stops and limits assist you in this: when the markets move against you, the usual stops will close your stops automatically.
- Moreover, there are no vouchsafing measures against slippage;
- Slippage risk might be done away with when guaranteed stops are closed out at precisely the price you indicated;
- When the market moves against you, trailing stops will close your position, having followed positive price movements;
- When the price nudges your chosen level, limit orders will close your position, having followed your profit target.
FX market volatility can put your peace of mind completely in disarray. Unless you have all hues and colours of your emotions under your firm control, you risk taking decisions you will find condonable later on. Whether you let our emotions take you for a ride, or if you can rein them in – says a lot about your understanding of the market. So play the market with an even, passion-less, clinical hand.
Trading on the news
Forecasting the price movement of currency pairs is no mean skill, given that many factors could lead to the market in flux. So educate yourself on how to best deal with abrupt news releases, central bank announcements and the market sentiment. The latter itself needs in-depth getting used to having that handle enabling quick, sure responses to sudden change.
Get that outline of Forex risk management out front and centre. Flesh out all the points with the peculiarities of your envisioned trading plan. Managing risks in Forex trading becomes easier after lots of practice. Take up a demo account. Trade with virtual money, but take the simulated outcomes well to heart. Forex Risk management and components thereof are rudimentary essentials. Get them under your belt ASAP: that will pay rich dividends down the road.