Risk Management is the primary cause for a successful or unsuccessful trading experience. A sound risk management can yield a steady accumulation of profits, and increasing P&L, while a poor risk management can wipe out an account in a very short period. Most novice (and sometimes even more advanced) traders tend to make few critical mistakes when it comes to risk management, mistakes that can easily be identified, addressed, and rectified. In this article we will review the common mistakes that we tend to repeat and should avoid.

 

Understanding Leverage

Leverage is a key ingredient in trading. As we want to gain substantial returns, we use leverage to increase our capital base. Leverage is basically a loan that our broker gives us for trading purposes (a.k.a, trading margin). Most Forex brokers use 1:200 leverage, which means that every 1 currency unit that we put, buys us 200 units for trading purpose (for example : we deposit 10,000USD, which enables us to trade up to 2,000,000USD , or 20 lots in lot size). The leverage bears great risk, if we don’t know how to use it wisely. A 1:200 leverage means that if we utilize the maximum amount on one trade , and the trade loses 0.5%, we will be asked by the broker to put more money to keep the position opened (in other words, a “margin call”). As we can see the portion of equity that we use will determine how much loss we can withstand before we are forced to close a position. As much as it is tempting to trade big amounts, the available equity needs to be taken into consideration to avoid “margin calls”.

 

Analyze, Back-test and Arrive to Conclusions

People tend to think that trading is what we see on the big screen, and TV series about Wall St. and the hedge fund businesses. The truth of the matter is that it is nothing like that. A large portion of the trader’s day is dedicated to the footwork of trading such as; analysis of the current positions, risk and possible scenarios that can jeopardies the P&L. Also, it is vital to look at closed positions and understand what we did right and what we did wrong (not in a sense of “I shouldn’t buy/sell”, or “If only I had a crystal ball”, but rather “how could I mitigate the risk in a more effective way”), and what we did right (which is also very important to understand). Once we analyze the closed trades and note the conclusions that arise from our analysis, we will be able to avoid trading mistakes and repeating patterns of bad trading. Most traders lack the use of powerful assistance of “paper trading”, as they feel that it doesn’t get them anywhere in making money. But that assumption could not be more wrong.  Paper trading lets us experiment, test new strategies, and get insights without bearing the risk. The way we see it, trading is 80% analysis and 20% taking positions.

 

Preparation

People devote too little time to building the strategies that they execute. Some traders will trade based on a hunch, without taking serious time to prepare, and come up with an exit strategies when they take positions. Increasing the profitability of any trade involves careful preparation, including various levels of analysis (whether it’s technical or fundamental). Also, upon taking a position, a trader should know where to place the stop-loss and take-profit orders. Although it’s tempting not to place a stop-loss, it is essential to do so, as this will protect us from significant losses, which can end up wiping out our fund, while we need to define where we lock our profits. Furthermore, once we define the stop-loss, we need to adjust the position size, such that we will know, upon initiating the position, the maximum loss that we can suffer (if the market goes against us). A good risk/reward (stop-loss/take-profit) ratio should be 1:1.5 or above, meaning that if we risk ourselves with 1% stop-loss, we should aim to take AT LEAST 1.5% profit. As we can see, we should aim to trade only trades that meet such minimum criteria, as this will ensure that in the long term we will be profitable, despite stopping out on a position every now and then.

 

Don’t bite off more than you can chew 

Sometimes, traders tend to have unrealistic trading goals. We all want to be wealthy, but we must set ourselves realistic goals, that will both meet our risk appetite, and will be feasible to achieve. It is important that we will risk only amounts that we will comfortable loosing (obviously we don’t want to lose, but we need to assume the worst and see that we can live with that). Once we set our daily target/ maximum loss, we should stick to the target (or the maximum daily loss) and be disciplined (meaning once we hit the target we should stop trading for the day.

 

 

 

Note: All information on this page is subject to change. The use of this website constitutes acceptance of our user agreement. Please read our privacy policy and legal disclaimer. Opinions expressed at FXstreet.com are those of the individual authors and do not necessarily represent the opinion of FXstreet.com or its management. Risk Disclosure: Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.

Education feed

Editors’ Picks

EUR/USD coming up for a breath of air in support

EUR/USD holding up at critical support in the hourly chart. ECB and Fed are in focus with critical data to end the week. The end of the week for European and US markets will bring plenty of key data for which could still some volatility for traders to enjoy. 

EUR/USD News

GBP/USD wobbles around 1.3800 on Brexit, inflation chatters, UK Retail Sales, PMIs eyed

GBP/USD struggles to extend pullback from monthly high. UK PM Johnson ready to compromise Brexit, NI protocol terms, British covid infections jump. Inflation expectations jump to multi-year high in the UK, US.

GBP/USD News

USD/JPY struggles near 114.00 ahead of US PMI

USD/JPY continues to extend the previous session’s sluggish momentum on Friday. The pair stayed in a relatively narrow price band of 114.00 and 114.50.  The US dollar trades below 94.00 tracks higher US T-bond yields. The Japanese yen gains amid a risk-off mood.

USD/JPY News

Editors’ Picks

EUR/USD coming up for a breath of air in support

EUR/USD holding up at critical support in the hourly chart. ECB and Fed are in focus with critical data to end the week. The end of the week for European and US markets will bring plenty of key data for which could still some volatility for traders to enjoy. 

EUR/USD News

GBP/USD wobbles around 1.3800 on Brexit, inflation chatters, UK Retail Sales, PMIs eyed

GBP/USD struggles to extend pullback from monthly high. UK PM Johnson ready to compromise Brexit, NI protocol terms, British covid infections jump. Inflation expectations jump to multi-year high in the UK, US.

GBP/USD News

Gold flirts with $1,790 hurdle on mixed concerns ahead of US PMI

Gold refreshes intraday high to $1,787 during the four-day run-up amid early Friday. The yellow metal witnessed pullback the previous day amid firmer USD, on relation fears, but the latest sentiment-positive headlines seem to have favored the gold buyers.

Gold News

Ethereum Classic price lags behind Bitcoin and XRP despite upcoming rally

Ethereum Classic price action for the Thursday trade session has been the definition of a whipsaw. The daily candlestick open has dropped as much as 9.5% and spiked higher by as much as 10.5% - big swings in all directions.

Read more

The idea of inflation falling back by (say) March is a fantasy

We get some non-movers today like the Philly Fed, Sept existing home sales, and leading indicators, but let’s face it, jobless claims own the space. Claims are not behaving as expected and are wildly at odds with job openings. 

Read more

RECOMMENDED LESSONS

7 Ways to Avoid Forex Scams

The forex industry is recently seeing more and more scams. Here are 7 ways to avoid losing your money in such scams: Forex scams are becoming frequent. Michael Greenberg reports on luxurious expenses, including a submarine bought from the money taken from forex traders. Here’s another report of a forex fraud. So, how can we avoid falling in such forex scams?

What Are the 10 Fatal Mistakes Traders Make

Trading is exciting. Trading is hard. Trading is extremely hard. Some say that it takes more than 10,000 hours to master. Others believe that trading is the way to quick riches. They might be both wrong. What is important to know that no matter how experienced you are, mistakes will be part of the trading process.

Strategy

Money Management

Psychology