Foreign Exchange Trading - Ways of Managing Risk

by Elaine Berry
There's no doubt - there is risk in any deal involving foreign exchange trading. Currencies are wildly volatile! They are affected by all sorts of factors and some of these factors are completely unpredictable. Big climatic or weather events like floods, earthquakes or tsunamis can have a massive impact on currency prices. Election results bringing changes in government; company collapses or takeovers; an unexpectedly good or bad set of government figures - all these can have a major effect. Remember the impact of 9/11 on currency prices throughout the world - nobody could have predicted that!
Because of this, there is one Golden Rule in Forex trading, as with all types of trading: NEVER trade with money you can't afford to lose.
But as you become more experienced in foreign exchange trading, you learn ways of reducing risk and avoiding large or frequent losses. Of course you will have losing trades. But you must learn ways of managing risk if you are going to be a successful Forex trader. · Make sure you understand the principles of technical and fundamental analysis. When the signals from both of these point in the same direction, you have the best chance of a successful trade. · Don't risk more than 2% of your margin account on any single trade. For example, if you have $400 in your margin account, 2% is $8, equal to an 8-pip move. · ALWAYS use stop-loss and take-profit orders. This is an absolutely fundamental rule. (A stop-loss order is placed below the current value of a currency pair if you are in a "long" trade - i.e. buying in expectation of a rise in value. You set the stop-loss order in case its value falls instead of rising. Conversely, the take-profit order is placed above the current market value of the pair. If the currency reaches that value, your order becomes an order to sell and this protects your profit.) · Be disciplined! And keep cool - don't be ruled by emotion, and DON'T get greedy. Never be tempted to stay with a long position that goes below your stop-loss order. You may have a "gut feeling" that it will come back up again, but gut feelings are something you just can't afford - at least, not until you are a VERY experienced trader.
Foreign exchange trading often looks difficult and technical. But the fact is, lots of people who barely got past third grade math manage to become very successful in foreign exchange trading. How? By learning simple rules like these and sticking to them. Forex trading can be so incredibly exciting, rewarding and profitable, it would be a pity to have a negative experience. Follow these rules and you won't need to.