There’s one important thing you need to understand about investing in the financial markets, particularly trading forex, stock, and other financial instruments: the potential profit is as big as the risk you bear. This is a principle known as risk-return trade-off, and it governs all investment instruments.
There is no such thing as a high-return low-risk investment. When you are pursuing high returns on investment, you are also exposing yourself to more risk. However, there are ways to manage those risks and make them easier to bear. These risk management tips will help you stay on top of your trading risks at all times.
Source: TodayTrader
Determine Your Risk Tolerance
Before you start crafting strategies for managing trading risk, you need to first determine your risk tolerance. Risk tolerance is basically the amount of risk – loss – you are willing to absorb, compared to the amount of money you can afford to invest and other factors such as your experience in the financial markets.
Risk tolerance dictates how you approach the market. If you have low risk tolerance and you cannot afford a series of bad positions, for instance, you need to build your trading ecosystem accordingly. This means lowering your leverage and making sure that your trade volumes are always well within your available margin.
Source: StockWatch247
Set a Ratio
When trading forex with top brokers like Easy Markets, you have a lot of risk management tools at your disposal. Two of the most important (and most common) ones are Stop Loss (SL) and Target Profit (TP). SL represents the lower limit, while TP is the target gain you want to achieve. Hitting either the SL or TP will automatically close your position.
You want a TP:SL ratio of at least 3:1. This means you are aiming for 90 pips in the forex market while being fully prepared to absorb a 30-pip loss. This isn’t a ratio for everyone, but it is a good starting point. If you have a higher risk tolerance, you can go all the way to 1:5 – yes, 30 pips profit for every 150 pips you are willing to lose.
On the other hand, you can choose to go conservative with a higher ratio like 10:1 or 8:1. Once again, this determines the trading style you need to adopt and the kind of trading strategies to use. A day trader can easily hit a 3:1 ratio, but scalpers may want to be more modest with their SL and TP to maximize profit.
Source: FX Empire
Have a Plan
The most powerful risk management tool, however, is a trading plan, especially one with all elements configured to suit your risk profile and trading style. This way, you know why you entered the market and can always decide to exit the position at the right moment, regardless of whether you bank pips or suffer a loss.
Combined, the three risk management tips we covered in this article will help you manage your trading risk better. It is impossible to eliminate risks completely, but you can take steps to prevent trading risk from eating too much into your available margin. That’s how you stay profitable at the end of the day.
