What Is Risk Management In Forex?
Risk management refers to the trading techniques traders can employ to reduce risk exposure. Forex trading is all about currency rates, which can be quite volatile on certain occasions. Thus, traders need to protect their accounts against adverse price fluctuations.
What’s included in Risk Management?
Negative Balance Protection – NBP is a feature offered by some brokers which ensures that you do not lose more than what you have deposited in your account.
Here is a list of few brokers who offer NBP:
Risk To Reward Ratio – This ratio indicates the potential profit a trader can gain in comparison to the capital he/she may lose in a given trade. It can be better understood with an example:
Let’s assume, a trader risks $100 on a position to potentially gain $300, then, in this case, the risk to reward ratio would be 1:3. Ideally, a trader should at least aim for a ratio of 1:2, as only a third of positions should be profitable for breakeven.
Take Profit & Stop Loss – Potential profit and loss are defined through Take Profit and Stop Loss levels. Traders set TP and SL to close the position when the price reaches a predefined level.
How to place stop-loss appropriately?
Support & Resistance – For a long position, traders set the stop-loss slightly below the support level whereas, for a short position, the stop loss is placed just above the resistance level.
Trend Lines & Channels – Traders set stop loss above or below the trend line, but outside the channel.
For example, a trader opens a lot EURUSD Buy Order at 1.12085. To achieve a risk to reward ratio of 1:2, the stop loss level will have to be set at 1.12065 (2 pips) while the take profit level will be at 1.12125 (4 pips). The trader will only risk $20 to gain $40. The position of SL/TP levels depends upon the initial deposit of the trader. SL/TP levels can be set even further, provided the trader is risking below 1-2% of his/her personal funds.
Traders should keep in mind that the price of each pip depends upon the volume of their position and trading tool.
Trailing Stop – It is used to automatically adjust the stop loss level once the price starts moving in a favorable direction. Trailing stop will not just reduce the risks, but also lock in the profit a trader has gained already.
All traders should keep in mind that neither take profit nor stop loss is guaranteed. When there are sudden price movements within the currency pairs, orders might be executed at a different price than what was originally chosen.
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