Risk management in Forex trading is one of the most important aspects of any strategy. In fact, it could be argued to be the most important aspect of trading, since it helps you "stay in the game". I'll cover all aspects of risk management here, which are important for all Forex traders.
Both new and experienced traders, make the mistake of risking too much on each position. This can result in them wiping out their account in a few trades. In more extreme cases, trading accounts can be emptied with just one or two trades.
Through trial and error, I have found it is best not to risk more than 1-2% on each trade. I usually only risk 1% on a trade, especially if I have more than one trade open. This may seem like a small figure, but this is to ensure your trading bank can withstand a string of losing trades.
An important part of risk management in Forex trading, is to minimize losses using a stop-loss. You'd be surprised at how many people do not use them. Ideally, the distance between your stop-loss and trade entry, should be half the distance between your trade entry and profit target. This will ensure your risk reward will be at a ratio of 1:2, meaning that you could lose 6 out of 10 trades, and still make money.
If moving stop-losses during your trade, always move them in the desired direction of the trade. So when trading long, always move them up and never down. If trading short, always move them down, rather than up.
It is also very important to calculate your risk correctly, before placing your trade. For our example, we only want to risk 1% of a $2000 trading bank. Our risk on a trade is 60 pips.
We would calculate this by 1/100 multiplied by 2000= 20.
Then this figure would be divided by the amount of pips, 20/60= 0.333.
Finally, to work out the lot size and assuming that price was being quoted to 4 decimal places (0.0001), we would divide that figure by 10.
0.333/10= 0.033 would be our lot size for this trade.
Please note that when buying or selling a Japanese Yen pair, the final figure would be divided by 1000.
Finally, a good way to facilitate risk management in Forex trading, is to practice on a demo account. Practicing the calculations using a demo account, will mean little or no mistakes when using real money. You don't want to be faced with a situation where you have wiped out your entire account due to a mathematical error.
Practice will also ensure the methodology you are using to trade is working, bringing in steady rewards. You may be itching to start trading live, but practicing first will save you money in the long run.
The importance of risk management in Forex trading, should never be underestimated. Following all of the above, will help you manage your risk more effectively. Combine these with a solid trading method, and you will see your trading bank grow.
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