The dangers of Forex trading must be recognized.
In the past, I’ve already mentioned Jesse Livermore, not only was he famous because he earn a lot of money, but he was also famous because he lost it all many times as well. In reading his story, it quickly becomes apparent that Jesse hardly took risk management seriously.
Risk Management in Forex Trading
Risk Management involves approaching Forex trading with the awareness that it is a dangerous and risky endeavor and therefore one must always protect one´s assets from loss.
You are protecting your assets from two enemies:
- Yourself – You may not know it yet, but you are your own worst enemy. You rush into trades without thinking. You have bad days. You will trade when tired and lose. You will get bored and lose. You will have a beer while trading and lose. You will lose track of your own method and lose. You will have an argument with your wife and want to punish the market, and lose. You will try out a new idea before testing it and lose. You will take advice from a friend and lose. You will watch a film on your computer while trading and lose.
- The Forex Market – So you find your method, you are in a perfect state of mind and approach the market… what can go wrong? – The market can go wrong. When a method is created, it is constructed under a number of assumptions that need to be true. For example, a method may require a volatile market. It may be based on the coming of news, it can be based on decision or indecision in the market. If the relevant qualities are not found, then the method fails. You can do everything right and still lose.
Stop Loss: Defense Mechanisms To Protect Your Money
A stop loss is what you place on a trade to make sure that if you are losing, you get out of the trade and don´t lose too much.
A stop loss can be placed when you initially make the trade. If you do not place a stop loss on a trade, you are probably clinically insane. One important aspect of creating a Forex trading method is to know when to get out of a losing trade. Currently, when I am trading, I place a stop loss when I initiate the trade and this is the ultimate limit to protect me (generally from my stupidity) and I also have another stop in my mind, signals in the graph that suggest to me that I need to think about getting out.
Your stop loss influences how much money you should place on a trade. It is generally advised that you don´t place more than 5% of your money on a stop.
For example, you have £1000 in your account and your stop is 50 pips. Consequently, 5% of 1000 is £50 and so this is the amount you can risk in a trade. Your stop is 50 pips which means that the computer will automatically delete you from the trade when you have lost this figure. You can spend £50 in 50 pips which means that the maximum money you can place per pip is £1.
When I started trading, I actually found this figure too traumatic… you don´t want to be spending quantities of money that trigger emotions. After the initial trading period (where you use minimal quantities of money), I then used 2.5% of my account as a stop. A beginner trader will probably think that this value is too small because they have visions that they want to earn big bucks. But when you are actually in a trade and it is going against you, you will praise the day that someone came to you and mentioned the figure 5%!
How Do You React When You Lose?
The temptation is that you want to increase the amount of money per pip to recoup your losses. This is NOT what you do!
The correct response is to reduce the amount per pip to follow the 5% rule. You need to earn the right to trade with bigger money. If your system works, then it will work and you will earn more money! – If it does not work, your risk management will inform you, because you will be trading with smaller quantities of money.
A person always needs to be honest with themselves. Are you doing this present trade because you are following a system that works, or were you being emotional when you entered? – If you suddenly come to the realization that you made a mistake for whatever reason, the correct response is to get out immediately. Whatever loss you are currently on is about to get worse. Always be aware of the dangers of Forex trading.
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