You should build an accurate plan and follow it meticulously, leaving emotions aside. It is up to you what you’ll include in this plan. However, there are basic aspects your risk management system should contain otherwise it will be useless. Let's take a look at these aspects.
About Investments
You’ve probably already heard about this basic rule but I will repeat - make sure that you invest only those funds that you are not afraid to lose.
If you put on stake money you need to spend on food tomorrow, each of your trades will be based on emotions. When your trading decisions are influenced by feelings, you begin to make mistakes that might eventually destroy your whole investment.
Set a Risk Level for Each of Your Trades
You should not put everything on one trade, even if it seems that the chance of success is approaching 100%. Each of your trading positions should risk only 1-2% of your total capital. That is, if your investment is $1,000, then your trade size should be $10-20.
In order to do this, you should control the volume of your positions in lots. If it seems difficult for you to calculate the required size, you can use special calculators.
It’s very important to always maintain these levels in your trading. Even if you have made several successful trades in a row, it doesn’t mean that you should increase the volume of your positions.
Carefully Watch the Risk to Reward Ratio
Not every trade is worth opening. Before you enter a trade, there are three important steps to follow:
- Set a Stop Loss
- Set a Take Profit
- Calculate the risk to reward ratio
Once you set both levels from the list above, you will know how much you might lose or gain in this particular trade. With proper risk management, the risk to reward ratio should be set to a minimum of 1:3. For example, if Stop Loss is set at a distance of 10 pips from the entry price, then Take Profit should be at least 30 pips away from the same point.
Use Trading Leverage Correctly
Leverage provides traders with an opportunity to open larger positions with smaller investments. The higher the leverage the more profit you will receive from each potential transaction. But at the same time, the risk level of your trades is also growing.
It is very important to learn how to correctly choose the leverage size for each individual transaction. It is worth choosing a smaller size for trades with a larger volume, as well as for long positions with a duration of more than one day.
You should also pay attention to the volatility of your trading pair. The higher the volatility, the lower your leverage should be. Therefore, it is better to use smaller leverage for major pairs than for exotic pairs.
Remember About the Correlation of Trading Instruments
If you trade on several markets at the same time you should remember that they may overlap. When opening trades for pairs with the matching currencies, remember the following:
- Positions can cancel each other if their base and quoted currencies at the same. For example, you open two transactions in one direction on the USDCAD and NZDUSD pairs. In case the US dollar price sharply rises or drops, your positions will cancel each other and you will not earn anything.
- If you trade pairs with a matching base or quoted currency, then your balance may drop sharply when the currency value falls or increases. For example, if you buy AUDUSD and AUDCAD at the same time, then when the value of the Australian dollar falls, your balance will drop twice faster.
Control Your Emotions
This is pretty obvious, but it’s very important for risk management to always follow your plan. When you trade using your emotions, following the plan becomes simply impossible. Therefore, you should learn to trade putting your feelings aside. Keeping a trading journal might help you with that.
Remember that losses are an integral part of Forex trading. The aspects described above will not help you get rid of losses but will teach you how to manage their quantity and size.
Your risk management system can constantly evolve and improve. Once your plan is built, test it first on a demo account to make sure it actually works. Good luck!