Before you begin trading, it is important to understand risk management.
In fact, risk management is probably the most important topic for you to read up on.
This is because in order to make money, we need to understand how not to lose money or at least, how to limit the amount of money we lose at any one time. Risk management is more important than ever in the time of online trading where trades can be done instantaneously and the adrenaline rush that comes from a potentially big payout can make people lose their sense of caution.
Besides for working on your habits and emotional control, there are aspects of trading you must understand in order to help you understand how to manage your risk when trading Forex.
Calculating Your Odds of Success
The first step in risk management is calculating the odds that your trade will be successful. This will require both fundamental and technical analysis which will help you understand the market in which you are trading. This will help you decide whether to even take the trade. Once you have decided to trade, you need to know how to management your risk as there is risk even with the most well-planned trade.
State Your Risk
Your risk for any trade is the difference between where you choose to enter the market and where you draw your red line of exiting the market if your trade reaches that level. If this risk is acceptable to you then you will be able to move forward with the trade.
If that risk is too high and you will not be able to cope with that loss, then you cannot take the trade. Taking the trade regardless will put a high level of stress on you and you will be unlikely to trade objectively or successfully.
Trading Capital and Risk Per Trade
An important aspect of risk involves how much trading capital you have. You need to be aware of how much you can afford to risk per trade and typically this should be limited to 1-2% of your capital. This means that if you have $5,000 in your trading account, the maximum amount you should risk per trade is 2% or $100. In other words, the maximum amount you can lose in any one trade would be $100, leaving you with plenty capital to continue trading.
Leverage has an important place in understanding risk management. Leverage is the money the broker gives you which allows you to trade bigger positions than your capital would allow. If the broker offers 100:1 leverage, your $1,000 would allow you to trade a $100,000 position.
If you make a profit, the return will be significantly increased; however, the opposite is also true and any losses will also be significantly increased. Make sure that you understand how leverage works and what a one pip profit or loss would mean for your account before you accept leverage of any level.