Why Risk Management Matters in Forex Trading
Risk is the uninvited guest of any trade. Certainly, this does not amount to betting (Forex trading is not and will never be gambling), but it is still speculative trading. The very concept of speculation brings into play dynamics that have to do with the logic of danger. It is essential for any trader, whether expert or not, to practice forex risk management by keeping risk under control. It cannot be eliminated entirely, but it can be controlled. Once controlled, if a trader discovers that the game is not worth the candle, the position is closed. The issue is simple on paper.
What Controlling Risk Really Means
But what exactly does controlling risk mean? The term "risk", translated into everyday operations, coincides with loss, whether potential or real. Controlling risk therefore means controlling losses. Now, it is obvious that all traders, even the most absolute beginners, know that they must exit the trade when the air becomes unbreathable, when defeat risks turning into a rout. The difference lies in doing it "technically" rather than "emotionally". In the first case, a trader reacts instinctively, without the comfort of numbers, and usually gets the timing wrong. In the second case, rationality takes over, simply exiting when certain conditions are met. Conditions, to be clear, decided beforehand, with a cool head and with the support of numbers.
Two Rules for Keeping Losses in Check
In concrete terms, what does all this mean? Essentially two things.
One, keep an eye on the ratio between potential gain and potential loss. If the ratio is 1 to 1, that is, a trader risks losing 100 euros and can gain the same amount, that is not a great deal. The best ratio is 3 to 1. 2 to 1 is already less convenient and the game may not be worth the candle. The important thing is to know it beforehand. In a sense, it is knowing what death the trade will die if things go wrong. This phrase, apparently as tragic as it is unrelated to the world of trading, perfectly summarizes the spirit of money management.
Two, don't bite off more than you can chew. Popular wisdom comes to the aid of the trader. It is necessary to "set the risk" based on the size of the account. When the potential loss exceeds 2 or 3% of the account, it is best to exit. Regardless of the feelings the trader experiences, the instinct that says yes, the market will soon turn for the better and the trade will be a winner. It is an iron rule that compensates for the typical loss of clarity that involves traders in the race. Whether disciplined risk control like this makes forex a suitable long-term investment is a separate question worth exploring; see forex trading a safe investment.
