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A Dive Into Risk Management Strategies In Forex

by Member #1746974

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Trading risk management is an important topic to understand in the world of trading. Traders would expect their potential loss to be small while being able to make as much profit as possible in every trade. Visit MultiBank Group

The reason why several Forex traders incur loss is not because they don’t have sufficient money or experience or because they’re not well informed about the market, but because their risk management is poor. Proper risk management is important and a must if you want to become a successful trader.

****What is forex risk management?****

Forex risk management allows you to put in place a set of rules and regulations to make sure that the negative aspect of a forex trade can be managed. An effective strategy demands solid planning right from the beginning as it is best to have a risk management plan in place before you actually put your money at stake. 

****What are the risks of forex trading?****

  • Currency risk refers to the risk associated with fluctuating currency prices, which have the power to make purchasing foreign assets pricier or cheaper.
  • Interest rate risk refers to the risk associated with the rapid increase or decrease in the rate of interest which could have an impact on market volatility. Interest rate changes could affect FX prices as the spending and investment levels throughout the economy would either rise or fall on the basis of how the rates change. 
  • Liquidity risk refers to the risk because of which you wouldn’t be able to purchase or sell an asset immediately to avoid a loss. Despite the fact that the forex market is highly liquid, it could undergo phases of low liquidity on the basis of currency and government policies which may affect foreign exchange
  • Leverage risk refers to the risk of increased losses when trading on margin. Given that the initial outlay is lesser than the FX trading value, it isn’t hard to lose track of the money you put at stake.

****Manage risk in forex trading****

  1. Understand the forex market

Forex trading functions in a way that is similar to any other exchange where you purchase an asset with a currency where the market price is a clear indicator of the amount of a currency you’d need to be able to purchase another currency. The first currency that appears in a forex pair quotation is known as the base currency while the one that follows is known as the quote currency. 

Here are are three different types of forex market:

  • Spot market: It refers to the physical exchange of a currency pair which happens at a certain, precise point at which the trade is settled – ie ‘on the spot’
  • Forward market: This is a contract where the involved parties mutually agree to purchase or sell a particular amount of currency at a certain price, at a particular date in the future.
  • Futures market: This is a contract where the involved parties mutually agree to purchase or sell a particular amount of currency at a certain price, at a particular date in the future. Contrary to the forwards market, a futures contract has legal sanctions.
  1. Get a grasp on leverage

When you predict forex price movements with CFDs, you essentially trade on leverage. This allows you to gain complete market exposure on the basis of a nominal initial deposit which is called margin.

Though trading on leverage includes several advantages, it has certain downsides as well like increased losses.

  1. Build a good trading plan

A trading plan could help you ease your FX trading since it works like your personal decision-making tool. It could be easier for you to stay disciplined in the volatile forex market. The goal of a good trading plan is to address key questions, like what, when, why, and how much to trade.

It is of utmost importance for your forex trading plan to be suitable for your personal requirements. It would not solve your purpose to mimic another trader’s plan as they may have different trading goals, attitudes, and ideas. It’s nearly certain that their available funds as well as time would differ from yours. 

A trading diary is yet another tool that would help you keep track of all that goes on as your trade right from your entry and exit points as well as how you felt emotionally during your trades. 

  1. Set a risk-reward ratio

In each trade, the risk you’re willing to take with your capital must be worth taking. Ideally, your profits should be more than your losses. Your goal is to earn money in the long run, despite the fact that you could end up incurring some loss on individual trades. Your forex trading plan needs to have a set risk-reward ratio to be able to weigh a trade’s worth. 

To ascertain the ratio, compare the funds you’d risk for an FX trade to earn profit. 

  1. Use stops and limits

Given the fact that the forex market is particularly volatile, it is essential to make the  entry and exit points of your trade clear prior to opening a position. You will be able to do this with the help of different stops and limits.

  1. Manage your emotions

A volatile FX trading market could be detrimental for your emotions – and it is something which could have a solid impact on your success as a trader. Emotions like fear, greed, temptation, doubt and anxiety could be motivators or affect your decision making which will directly affect your trade results. 

  1. Keep an eye on news and events

It can be hard to predict price movements of currency pairs since there are several factors which can cause market fluctuations. To ensure that you’re not taken by surprise, monitor central bank decisions and announcements in addition to political news as well as market sentiment.

  1. Start with a demo account

The purpose of a demo account is to mimic the experience of trading in a live market so you get the hang of how the forex market operates. The key difference between a demo and a live account is that you would not actually be putting any money at stake with a demo account as it is aimed at helping you gain confidence in your trading skills in a risk-free environment.

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