When it comes to forex trading, risk management is pretty much the most important thing there is to know.
Simply put, if you take on too much risk, you may lose more of your capital than you can afford.
Eventually, you may lose so much of it that trading is no longer worthwhile or even possible. And once you’ve reached that stage, it’s game over. You’re no longer a forex trader.
See also: Why Forex traders lose money: 14 common reasons
Risk management in forex trading
Generally speaking, you should never risk more than 1-2% of your account balance per trade.
The idea behind this principle is that, even if you have several losing trades in a row, it won’t have too much of an impact on your capital. So long as your strategy is profitable, you should still have enough capital to be able to move forward, overcome the dip and carry on growing your account. You’ll live to fight – and be in profit – another day.
This is so important because, after a series of large losses, it’s much harder to bring your account back up to the level it was. You do not want to find yourself in a position where you have to dig yourself out of a hole.
Once you set foot on this path, you could become vulnerable to emotional trading. The stress of having lost a chunk of your capital could trigger you to take on even more risk in order to try and get it back. And if this trade fails, you’ve then lost an even bigger chunk of your capital. Before you know it, you’ve blown your account.
Emotional trading
Another key rule of trading that goes hand in hand with good risk management is never trading with money that you can’t afford to lose.
Let’s make an example. Let’s say you enter a trade in accordance with your strategy. You believe that the odds are in your favor and that you’ll make money. But of course, you know there is a chance that it might not work out, so in order to minimize your losses, you set a stop loss.
So how do you feel if the trade goes against you and hits your stop loss?
It’s not a great feeling – after all, losing money is not the goal here. But ultimately, you should be able to accept it – after all, that’s where you set your stop loss, right? If you weren’t OK with losing that money, then why did you enter that trade and run the risk of losing it in the first place?
The point I’m making here is that where you incur losses, they should be acceptable. They need to be. You will not win every single trade. No trader is infallible. If you find that the loss from a trade is unacceptable, then you could be taking on too much risk, or you’re trading with money which you can’t afford to lose. You shouldn’t be doing either of those things.