Risk Management is the most important in Forex but mostly ignored and misunderstood by traders. A beautiful trading system cannot imagine without proper risk management. Your first job as a trader is to manage risk.
Larry Benedict: “You are not a trader; you are a risk manager.”
The world economy is very much uncertain, we cannot perfectly predict what is going to happen. All we can do is forecast, assume, and observe. We should continuously look for favorable situations for entering a trade. Even though everything may seem perfect, the market can react opposite due to many factors. So, to survive for a longer time and save our investments we must have a good risk management system that aligns with our trading plan and our trading behavior. Once we fixed our risk percentage, we must not vary or change with time.
We must fix the risk percentage and stick to it. Preferably no more than 3% of the balance per trade. Always give some room to the SL to breathe. So, it cannot be hit so easily, even not too far. It must be feasible and calculative manner.
Lot size, SL, TP and Risk: Reward calculation according to risk management:
Suppose 100$ balance and 2% risk. 2% risk per trade= 2$
Pip value: for 0.01 lot= 0.1$. So, Risk amount/pipvalue= pip (SL)
2/0.1= 20 pip, Standard R:R = 1:2
Then, Sl= 20 pips and TP= 40 pips
So if we lose we will lose 20*0.1= 2$ and if we win we will gain 40*0.1= 4$.
Now if, SL=10 pips and risk is still 2% and same R: R ratio,
We can use lot size= 0.02
So, Risk= 10*0.1*2= 2$.
How to determine the percentage of trade to be profitable?
Suppose according to the same above example we took 10 trades and calculate 2 scenarios.
Scenario 1: 3 won and 7 losing trades.
Winning trades= 3*4=12$, Losing trades= 7*2= 14$
So Gain= -2$
Scenario 2: 4 won and 6 losing trades.
Winning trades= 4*4=16$, Losing trades= 6*2= 12$
So Gain= 4$
Finally, in this risk management system, we need at least a 40%-win rate to have positive growth.
Lot size and SL calculation
Assume 500$ account and 5% risk.
So, 500*0.05= 25$
0.01 lot SL= 25/0.1= 250 pips
0.05 lot SL= 25/0.5= 50 pips
0.1 lot SL= 25/1= 25 pips
0.2 lot SL= 25/2= 12.5 or 13 pips
So, Risk amount/pip value= SL distance in pips
Sometimes we get SL distance from measured objectives, From predetermined SL we can calculate lot size from pip value. Then, Risk amount/SL distance= pip value
Suppose 50 pip measured objective
Pip value= 25/50= 0.5,
So the lot is 0.05
Ways to manage risk:
⚛️ Make sure other trades cover up your one losing trade.
⚛️ Should have a predetermined lot size and should have systemized lot size calculation.
⚛️ Judge your performance according to sessions and also time frame. Then stick to that and improve the suitable one.
⚛️ Must have diversification (different asset classes) or a balanced portfolio. In the diversification, the process is careful about over-leveraging. Too many instruments are also dangerous. A good habit is not to have more than 10 trades simultaneously. Remember trading co-related currency pairs are not called diversification.
⚛️ Should have optimal SL & TP. Not too wide and not too tight. Use the measured objectives better is 70 to 80% of the measured objectives.
⚛️ Trade more predictable pairs.
⚛️ Invest in assets that you understand.
⚛️ Write down your trading plan and everything you can.
⚛️ Don’t be greedy and don’t take big position sizes.
Always expect the unexpected from the market. Statistically improbable events occur far more often than they theoretically should.
Mark cook: “The main thing is that every trader has to be honest about his or her weakness and deal with it. If you can’t learn to do that you will not survive as a trader.”
“Being wrong is acceptable but staying wrong is totally unacceptable.”
Good traders have humility. They have the ability to admit when things are not going their way and make a new decision. They know that part of trading is being wrong.
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