Many traders rely on the FX markets as their primary source of income. They’re truly living “the dream.” But a lot more people fail at making a living off forex — often because they’re horrible at risk management.
Beginning traders know they can’t make money without risking it, but some lack sound risk-management strategies that mitigate losses and keep them in the game long enough to make a profit. Don’t be one of them! Here are three risk management strategies that every forex beginner needs to know.
1. Trade Only What You Can Afford to Lose
You’ve heard this advice so many times that it probably sounds like a public service message: “Don’t risk more than you can afford to lose.” But just as when telling people “don’t speed” and “don’t text and drive,” repetition is key to making it stick:
Don’t risk more than you can afford to lose.
The longer you trade forex, the better you get at “surviving” and making a profit. Pretty soon, “not risking more than you can afford to lose” becomes an iron-clad law that you never violate. Beginning traders are a different story, and it’s not their fault.
FX markets play with your head until you get in over your head — by irresponsibly averaging down on losing trades and dumping more and more capital into the market. If you lost money because of that, be thankful for the lesson. Most of us learn the hard way before we listen to practical advice.
2. Consider Percentage-Based Rules to Mitigate Losses
To keep your head straight on forex and prevent losing more than you can afford, establish some realistic limitations on what you can lose per trade per day. Here are two strategies of experienced traders.
Use the 1 percent or 2 percent risk rule for every trade. To keep themselves in check, some traders don’t permit themselves to risk more than 1 percent or 2 percent of their total capital on a single position. For example, if you have $50,000 to invest and don’t want to lose more than 1 percent of that on any single trade, you’ll set the stop to trigger when losses on each trade get to $500. You might have an even higher appetite for risk and set your stops at 5 percent or 10 percent, but unless you know what you’re doing, this could get you into trouble fast.
Implement a daily stop loss rule of 2 percent or 3 percent. In addition to the 1 percent or 2 percent rule for individual positions, forex traders may also implement a daily stop loss. Perhaps you choose a daily stop loss of 3 percent of your investment capital. Once you hit the stop, you’ll exit your positions and leave forex for the day.
Stop-loss strategies move you away from “wild gambling” into the realm of “managed speculation,” which is a much better place to be if you want to keep trading long enough to earn a profit.
3. Don’t Widen Your Stop Loss After Entering a Position
This is another ironclad rule you need to follow: Never widen your stop losses. Use a sound investment strategy to select your trades and set your stop losses — and never adjust them. Whatever you do, resist the urge to change the stop losses. It could be painful, but when you consistently mitigate losses and start earning money because of it, you’ll understand the wisdom.
As for the selection of your stop loss, you could use the 1 percent or 2 percent rule described above. You can also rely on technical analysis according to your strategy. For example, you might set the stop at the next resistance level or if it goes past a trendline it just broke. Just make sure you stick with the same strategy consistently. That way you’ll know if it’s working or if you need to change it. Remember: Once you set that stop, resist the urge to change it.
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