Risk management in the Forex market is a very important concept that many seem to forget. The average retail trader is looking for the best Forex trading strategy, the best indicators, etc. while ignoring the most important factor to success in Forex; Risk Management.
If you are a visual person who prefers to watch rather than read, we have a detailed video on that here, otherwise, let’s continue.
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Risk Management in the Forex Market among Retail Trader’s
The most common risk management term you hear in the Forex market is the term, the risk to reward, If you do not understand this term, consider taking our free Forex trading course for beginners.
Risk in simple terms is the amount of money you are willing to lose per trade.
The reward is the expected gains or profits you expect to make should you win.
Risk management in the retail market involves having a risk-to-reward ratio of not less than 1:2. That makes sense, you want to win more when you win and lose less when you lose.
With such a risk-to-reward ratio, even if you lose half your trades and win the other half, you should be in profits. It doesn’t matter if your strategy is based on the flipping of a coin or the counting of stars, if you can land throw the coin 10 times and land 5 out of these 10 on its head, you make money.
That is the general concept of risk management in the Forex market among retail Forex traders. Unfortunately, that concept is implemented differently by each trader, and this accounts for the massive losses you see or hear about among retail traders in the Forex market.
While the risk-to-reward ratio is perfect, in the retail world, the risk-to-reward is applied to pips, not the actual dollar amount, that is wrong! For a risk-to-reward to have any meaningful impact, it needs to be applied to the actual dollar amount and be consistent over a period of time.
For some weird reason, the retail trader is more interested in pips than the actual dollar value of the pips. They would rather risk 50 pips in one trade to win 100 pips. Happy with that 1:2 risk to reward, they go ahead and take another trade with 300 pips stop and a 600 pips take profit, also 1;2 risk to reward ratio.
Except for this time, they lose the trade and end up in massive panic attacks! So how do professionals manage risk in the Forex market?
Professional Risk Management in the Forex Market
While pips are important, what is more, important is the actual amount involved in the trade. In my eyes, pips don’t matter. It doesn’t matter if it is a 100 pips stop or a 1000 pips stop. In managing my risk I am more interested in the dollar amount.
Here are a few steps to manage your risk like a professional in the Forex market.
- For each month, determine how much you are willing to lose per trade (actual dollar value)
- Having determined that, no matter the number of pips involved in the trade, adapt your lot size to meet the risk you have predetermined.
- This means that trades with smaller stop losses would have higher lot sizes, compared to trades with higher-stop losses.
- The general idea is the vary your lot sizes to meet up with the actual risk you want to take in the Forex market.
- Do this consistently in the month, do not change the risk amount whether you are losing or winning.
- When losing, maintain the risk, that is the only way you recover quicker, and when winning maintain the risk, before you lose all you have gained and more.
- Ensure that the actual risk you are taking would allow you to take 100 losing trades continuously before your account come’s down to zero, the point is, do not risk more than 1% per trade, at worse 2% and that should be consistent for the month.
- At the end of the month, evaluate and determine what you would want to risk for the coming month, it could be less or more depending on how well you performed the previous month.
While this might sound trivial, the truth is that a Forex trader who knows and applies proper risk management in the Forex market would become successful over the long term over a Forex trader who keeps chasing the next profitable strategy.
There is no perfect trading strategy, only perfect risk management. Remember, we don’t spend pips, we don’t lose pips, we lose money. Pips are free, money? not so much!
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