Research & Tools

Risk Management

“Risk management is the single most important skill to have in trading. Understanding where you stand in market and how market moves will affect you and your money will truly differentiate a trader from a gambler, nothing else compares to that.”

– Founder of OEXN

  • Know your risk tolerance
  • Learn the basics
  • Read the news
  • Don’t get emotional
  • Position sizing
  • Time your trades
  • Don’t bet your house
  • Cut losses

What is risk management in FX trading?

Risk literally means the potential losses that could occur due to unexpected moves in the market against you. Every trader or investor have different risk tolerances, some of us may prefer investments that cater to high risk and high reward ratios, while others may prefer more conservative methods of investing. However, in the end it is important to remember that we are here to make money and thus should never take unnecessary risk.

Risk management means having a plan for when you enter a trade. You are always aware of how much you are willing to risk, when you should exit with a profit, as a well as when to cut losses. While the number one rule in any form of investing is that you should never trade with money that you cannot afford to lose, the number one rule in risk management is that you should know how much you are willing to wager, when to cut losses and never let emotions get the better of you.

Why it’s essential for traders to manage risk.

Risk management is not only a skill but also a form of discipline. As with any form of discipline, it is extremely difficult to maintain but will reward us handsomely if kept a habit. A good and well disciplined trader will know when to exit a trade with a profit, when not to trade and when to cut losses. A bad trader will continue to add on to his position even though he does not have the capital to do so, refuse to cut losses and often end up a situation where a margin call is around the corner. Always remember to treat trading seriously, as it is your hard earned money on the lines here. It’s never wrong to start all over again, but having the capital to do so is equally important.

Read the news, don’t trade it.

CPI, Non-Farm Payrolls, PMI, Fed interest rates are all major market movers, but are rarely good trading opportunities due to the uncertainty that revolves around these events. We strongly suggest to retail traders that major news events bring significant risk and often times the market gaps that happen after these announcements are totally unpredictable. Moreover, due to diminishing liquidity, trading costs tend to increase around these events.

Understand the basic strategies and the risks involved.

There are three basic strategies in FX trading, the Martingale, reverse Martingale and basic speculation. The basic Martingale strategy dictates that you will double up your position whenever you suffer a loss, and continue this increase in position until hopefully the trend reverses and you recover your losses, closing all your trades making a tiny profit. However, this strategy would only work in a perfect world where you have unlimited funds and a trend will eventually reverse. The reverse-Martingale strategy is exactly the opposite, it assumes that you capitalize on a winning streak and cut losses on a losing one. However the truth is no one will know when the trend will turn and whether or not the odds are in your favor.

Aside from these basic strategies, there is a plethora of other trading systems widely available on the web, and although some are very complex to learn, once you understand your risk appetite and how each system works, you will understand whether a system works for you.

It is also crucial to understand the basic financial metrics when measuring a trading system, for example it’s maximum draw-down, win-rate, holding times for different trades and reading equity and profit/loss charts. A good place to start is learning how to decide the different metrics on signals’ pages on different social trading communities.

The 8 pillars of risk management

Know your risk tolerance

How much risk you are willing to take and how it affects your investments is the first step.

Learn the basic

Learn the basics of finance, trading and how different economic news affects market moves and your positions.

Read the news

Knowledge is power, be constantly updated with financial news and you will understand how they affect the markets.

Don’t get emotional

Be disciplined and do not let your emotions take control, rationality is crucial to successful trading.

Position sizing

A good starting percentage is to use less than 2% of your available capital to enter a trade and do not let losses exceed 3% of your total capital.

Time your trades

Find good opportunities to enter a trade from technical or fundamental analysis, don’t buy or sell on a whim.

Don’t bet your house

Use money that you can afford to lose, and understand that trading is a long learning process that will take years to master.

Cut losses

Know when to take a break or step away from trading, sometimes trends will move against you constantly and taking a long break will be important for how to adjust your psychological situation.