What Makes a Trading Method Sound? Continued
Forex Trading Methods: What makes a trading method “good”?
Risk Management: I want to continue the discussion on how to find the right trading method for Forex trading. Formerly , I shared that for any Forex trading technique to be considered, it has got to be a total methodology ( insert link to prior article ) .
Today, I would like to add to that by talking about risk management. This is maybe the area where 95% of Forex traders screw up and lose cash. Handling risk is about reducing your losses AND about shielding trade capital by employing precise techniques to do each of these simultaneously.
What do I mean by that and why is it important?
First, most Forex traders make straightforward trading mistakes : they take too giant of a position and reveal themselves to significant and steep losses if the markets move against them. 2nd , they fail to guard their Complete account by permitting ONE trade to put their full account balance at risk.
Here’s a fast and maybe acute example:
Suppose a foreign exchange trader has a ,000 account balance. The forex trader takes a 5 standard lot forex trade on the EUR/USD pair. The currency exchange trader now has at least ,000 ‘margin’ at risk ( or fifty percent or more of the foreign exchange trader ’s account balance ).
For each one point that this currency exchange trade moves against the foreign exchange trader , the trader loses 1/2% of the total account balance. For details read this Forex Income Engine 2.0. At first glance, that may not seem like a steep loss. However, should the Forex trade move a total of fifty pips against the Forex trader , and the trader afterwards exits the position, the currency exchange trader ’s total loss would be an Superb ,500! ( 25% of the trader ’s account balance ). This is poor risk management and it often leads to finish wipeouts of Forex trading accounts.
How did we figure out that loss? One pip for the EUR/USD pair is the same as ( on the standard lot trade ). A fifty pip loss equals a financial loss of 0 ; and remember our example currency exchange trader had traded five standard lots — for a gigantic loss of ,500!
Instead, any trading technique should teach you highly specific rules for incorporating money management and risk management into each foreign exchange trade you take. Find out more see my Forex Income Engine Review.
Cash Management should involve the distribution of a currency exchange account among the varied trades a foreign exchange trader takes. As an example, currency exchange traders should never trade their complete account on a single trade, and should infrequently have more than some open positions. By using multiple positions, the foreign exchange trader distributes the chance among every one of the foreign exchange trades they have taken.
Risk management should involve the maximum risk in any SINGLE Forex trade, and should limit the impact of a losing Forex trade on the trader ’s account balance.
Here are 2 fast examples:
Money Management : A unproven foreign exchange trader takes four separate one lot trades on 4 separate pairs. Presuming here that every one of the pairs have a pip cost of on the standard lot, then the whole amount of the account being margined across all 4 trades is about 40% ( it could be higher relying on the pairs traded. With correct stop loss management in association with risk management, it is Doubtful the currency exchange trader would attract a complete 40% loss.
Carrying forward to chance management : In each one of the unproven currency exchange trades above, the foreign exchange trader risks only 2% of the trader ’s total account balance on each foreign exchange trade. That means a maximum loss of 0 per forex pair traded if ALL FOUR trades are stopped out. Total loss in this situation would be 0 — a way more recoverable eventuality than the 00 in the 1st currency exchange trade example.
Furthermore, Risk Management has the capacity to make loss recovery less complicated. As an example, in the 1st case, where the Forex trader lost 00, the trader would need a virtually 250% gain on their next trade to recover the lost value on the 1st trade.
In the second example the foreign exchange trader would need only an 8% gain.
A second part of Risk Management not generally debated in poor trading strategies is protecting gains. Though this starts as a dialogue on Exit Method rules, it’s also a factor of risk management. Once a forex trade turns profitable, it is imperative that the forex trader manage the gains with smart stop loss management. The worst thing a foreign exchange trader can do is permit a lucrative position to reverse and become a losing position. So , handling risk reaches to the protection of gains on a foreign exchange trade, just as it does defending against deep losses on a currency exchange trade.
Therefore, in considering any trading technique to be used in your Forex trading, you should make sure that risk management is not just debated, but obviously explained with the use of the trading technique. If risk management isn’t present, confusing, or not explicit to the trading strategy, you have to avoid using that trading method. Find out more see my Forex Income Engine 2.0 Review.
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