Forex

Risk Management on Forex: Basic Rules and Recommendations

Top 5 Risk Management Rules on Forex


Senior traders would say that there is no chance to build a successful career without risk management. Whatever your trade duration is, the trade should comply with unbreakable rules.

But what is the real value of risk management? What are the basic recommendations each trader can use? You will find answers to these and other questions in this article.

 

What Is Risk Management About?

Risk Management is the process of managing risks to reduce the likelihood of a negative outcome or reduce the losses. An extra check of the strategy signal or the use of Stop Loss can be called risk management.

You can’t trade on Forex by your own rules without following risk management rules. Market risks can feel a trader’s negligence and will start hitting them, which is quite likely to result in a total knock out.

 

How Does a Trader Profit from It?

Reduced Uncertainty

If your risks are under strict daily control, you can be sure that a negative result will not exceed a predetermined amount. For example, Forex traders rarely set the daily risk bar above 1-5%.

Such a trader has between 20 and 100 trading sessions in stock to catch a profitable trend. A trader often makes a “golden” trade after a series of losing ones, and this trade compensates for all the negative results and brings him or her profit.

Increased Efficiency

Risk management is about keeping your trading records. The more attention you pay to the result analysis, the more opportunities you will have to improve your trading strategy. One can get more insights from 10 quality and well-grounded trades than 1000 emotional and baseless ones.

This rule applies to not only the entry and exit points. One should analyze:

  • Position sizes
  • Multiplier’s value (leverage)
  • Guidelines for determining the right moment to increase a position or reduce its volume
  • The amount of fee for opening a trade or spread can also be considered if one prefers scalping.

This information will help you improve the trading system, which, in turn, will affect the financial results. You will also learn how to plan your trades. The trading journal log will help you develop a habit of analyzing and documenting.

 

Top 5 Risk Management Rules for Trading on Forex

It’s easy to set up a basic risk management system. Just follow these 5 rules. In due course, you can update them or add some new ones.

Rule one: determine the trade amount (lot)

Let’s say you have $1,000. How much can you invest in a trade if the daily losses are limited to $50 (5%), and the Stop Loss value is -10% for each trade? You will find the answer in the table below.

Multiplier Trade amount Fee (the approximate value for EUR/USD) Stop Loss value per trade (fee – Stop Loss -10%) The number of trades within the limit
х500 100 -15 -25 2
х500 50 -7,5 -12,5 4
х500 25 -3,75 -6,25 8
х200 100 -6,8 -16,8 2
х200 50 -3,4 -8,4 5
х200 25 -1,7 -4,5 11
х100 100 -3,4 -13,4 3
х100 50 -1,7 -6,7 7
х100 25 -0,9 -3,4 14
х50 100 -1,7 -11,7 4
х50 50 -0,9 -5,9 8
х50 25 -0,45 -2,95 16

The example of three different investment amounts shows that you can make no more than 2 trades worth $100 each or 1 trade worth $200 using an x500 multiplier within the set limit. It would be best if you prepared such a table, basing it on your risk attitude and the amount of money in your account.

Pay attention to the number of trades within the limit. For example, if you invest $100, you can only make 2 trades using an x500 and x200 multiplier. However, the first multiplier’s profit potential is 2.5 times higher than that of the x200 one. What’s the catch?

The thing is, each of these trades has a different cost of the point. Thus, for a EUR/USD trade made with an x500 multiplier, the cost of point will amount to $5, while it will be about $2 for the same trade amount with an x200 multiplier value. Accordingly, there will be a 5-point Stop Loss ($25 risk of a trade/$5 cost of point = 5) in case of the use of an x500 multiplier. If you set a value of x200, the Stop Loss will amount to 12,5 points. That is to say, a trade made using an x200 multiplier has lower chances that the chart might accidentally trigger the Stop Loss. This knowledge will help you choose optimal conditions in different situations.

For example, you plan to trade on the news. There will be a powerful jump in price at a certain point in time. As soon as you know when the impulse is to occur, you do not have to worry about how far you placed the Stop Loss. And since a sharp price change in the trade’s direction leads to high profits, it is advisable to use an x500 multiplier instead of an x200 one.

At the same time, it is better to use an x200 multiplier when intraday trading to keep the chart away from Stop Loss.

You should adapt the calculation of the trade amount to the trading strategy requirements. If only 30% of the signals provided by your system are profitable, it is better if you can make a few attempts.

Rule two: don’t trade on assets with high correlation

This rule suggests the need to avoid assets whose prices copy each other’s dynamics. If you are a professional trader, you may not observe it. Still, beginner investors sometimes do not even realize that they end up buying the same asset while trying to diversify their portfolio.

For example, a trading strategy gives a signal to sell EUR/USD, EUR/JPY, and buy EUR/CAD. These trades have different directions, but they all imply a strengthening of the EUR. Such a portfolio increases the risk of the negative experience of applying a trading strategy.

Remember: you should open 1 trade to test 1 trading idea. If the USD looks strong, it is not worth buying it against all other currencies.

 

Rule three: move Stop Loss in the right direction

Move Stop Loss only towards risk reduction. It is strongly recommended that you do not increase the limit of losses. Such actions are generally related to human emotions rather than risk management rules or trading strategies.

However, moving Stop Loss to the breakeven zone is the first step towards a successful trade. Traders use a Trailing Stop Loss, which automatically follows the current market quote.

With MetaTrader 4, you can set the distance between the Trailing Stop Loss and the quote. Every time the price exceeds this range, the order will move closer to the market price. This risk management rule eliminates the possibility of an initially profitable position turning into a losing one due to a trader’s bungling performance.

Rule four: limit your attempts to follow some trading idea

We often find ourselves in a situation where a trading strategy gives a signal to open a trade. But when we make a few efforts to follow this signal, we end up fixing the loss manually or having the trade closed by the Stop Loss.

To prevent bankruptcy, you must conduct an extra risk assessment and remember the following constants:

  • The maximum number of attempts per signal you can make (keeping in mind all the other limits)
  • Rules for repeated position opening. You cannot just open positions one after the other at random. You should use special tools to assess the situation.

For example, you get a signal and make a losing trade on a 15-minute time frame. It is better to check the signal on a higher timeframe of 30 minutes or 1 hour before opening another position. If the strategy signals contradict each other, the best solution would be to refrain from opening positions on this asset.

Rule five: do a history test of your strategies

The basic rule for risk management of any kind is the historical analysis of the management strategy. You should check the price movement in the past for any strategy you want to use. The research will not take long, but the results will improve the above recommendations. What is more, analyzing the historical trading data will save you money.

In general, the process of preparing a strategy for further use can be split into several stages:

  1. Getting to know the strategy rules
  2. Applying trades to the historical data
  3. Trading in a demo account
  4. Testing the strategy in a live account with minimum amounts
  5. Rules adjustment if needed
  6. Full use of the strategy

 

How Can One Manage the Risks and Earn on Forex Fast

Risk management sets strict limits for investors. It may seem that following these rules will postpone the prospect of making a profit by trading for several years. But this is not the case.

Forex traders can use a high multiplier (leverage) value. Its value can reach x500 on the Olymp Trade platform and 1:400 for most assets for MetaTrader 4.

Thus, the probability of increasing your deposit on Forex fast is not low at all, with an option of making a $1 trade that will be equal to a $500 worth of investment. If you open a $1 long trade on AUD/CAD at 0,90350 and close it 40 points above (at 0,90750), this investment will bring you more than 200% in profit.

However, even if your trading strategy is weak, you can still use two basic trading approaches. Please note that both mechanics can be referred to as high-risk investment management systems.

 

Pyramiding

This relatively new approach was designed for mid-term trades. It is based on the concept of a gradual increase in investment volume. Let’s say you sold AUD/NZD positions for $1400 on November 14 and 15. The trend was playing into your hands, and instead of fixing the profit, you invest another $1000 on November 25. If the AUD/NZD exchange rate goes down to 1,04000, you will gain more than $10,000 in profits.

Pyramiding aims to get high profits from trading on a single asset. Of course, the time frames may vary, but the recommended investment term starts at 1 week.

 

Loss Compensation System on Forex

The Loss compensation system is widely used in the FTT mode on the Olymp Trade platform. According to this system, you should at least double the trade amount each time your trading forecast is wrong to compensate for the drawdown.

The same approach applies to Forex trading. For example, you can invest $200 after making a $100 losing trade using an x500 multiplier and a Stop Loss placed at $20. Even if you manage to catch only a small pullback, you can at least make up for the lost $20.


As you could understand, the art of risk management on Forex includes reducing costs, creating a list of strict rules for opening a trade and monitoring it, as well as an ongoing process of improving strategies.

Apply at least a few basic recommendations today. The positive effect will not be long in coming.

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