Lesson#3: Forex Traders Stayin’ Alive With Risk Management
Well now, I get low and I get high [the markets are moving up and down]
And if I can’t get either I really try.
Got the wings of heaven on my shoes
I’m a dancin’ man and I just can’t lose. [we’re winning and feeling high]
You know it’s all right, it’s O.K.
I’ll live to see another day.
We can try to understand
The New York Times’ effect on man. [News can really get to you and they’ll call loudest at the tops and bottoms]
Whether you’re a brother
Or whether you’re a mother,
You’re stayin’ alive, stayin’ alive. [Staying alive in the markets is key]
Feel the city breakin’
And ev’rybody shakin’ [people are getting shaken out of the markets]
And we’re stayin’ alive, stayin’ alive. [Concentrate on risk management to prosper]
Extract from the lyrics of Stayin’ Alive by the Bee Gees
Wow, maybe the Bee Gees were closet forex traders because you can surely take the words of Stayin’ Alive as expressing the roller coaster ride of a trader.
Now it’s time to get serious.
Protecting Your Trading Capital Is The Stepping Stone To Success
One of the most important keys to becoming a successful trader is staying alive in the markets long enough for you to get the skills and learn the lessons. Staying alive takes a high level of risk management from the very beginning.
When I look back and reflect on my own trading journey I believe that one of the most important aspects of growing and succeeding as a trader is keeping your capital largely intact while you’re learning and growing.
Don’t run from risk, because we need it to make money. Success is all about the management of that risk.
I spent a lot of time learning about trading before I had the opportunity to trade. Coming from a fairly risk adverse background I was on the lookout for risk, could recognise which stones to turn over to reveal it and prepared an action plan for it. No wipe out in my street, thank you.
Many traders find risk easy to take; such is their comfort level and attitude with risk. Of course the gamblers out there call, “bring it on mate!”
Risk management is a lot more than making the decision of how much to trade. Risks can come at you like a freight train intent on wiping you out from a multitude of directions as we trade and manoeuvre through life.
Here are some examples of the risks you need to be aware of and manage when you trade.
Risk from the decision of how much to trade
When forex traders make the decision about their trade size they’re balancing how aggressive they’ll be to make a high percentage return versus the risk of ruin they’re accepting.
There’s a bulk of testing that clearly shows that there’s a risk of ruin if you trade greater than 2% of your account per trade. You’re in dangerous territory of coming to an abrupt stop if you trade more than 2% per trade and that’s not consistent with developing a successful trading business that’s sustainable over the long term.
On the other side of the coin, the larger you trade the greater is your opportunity for a big return, so for most of us it pays not to be overly conservative. When traders win trading competitions it’s usually a result of taking large risks with a high risk of ruin. There’s no glory in a competition with a modest result. It’s an all or nothing play to win aggressive style of trading.
It’s not just about how much to trade for each individual trade. A trader should also make other “how much” decisions like whether they should set any clear rules about how much to have at risk at any one time, how much to use as trading capital and a multitude of other “how much” decisions.
It’s sad to say that there’s always the ultimate risk that the broker’s business fails and with it goes your trading capital account. In fact this is more common than you’d probably like to think.
Big example failures are PFGBest and MF Global whose businesses went under leaving traders with no access to their trading accounts for some time and a significant loss of trading capital when only part of their trading accounts were ultimately returned.
But the good news is you can take steps to safeguard yourself from unnecessary capital loss from broker failure.
Computers and other technological devices and communications are fraught with problems. I’ve lost count of how many times internet has gone down, how often the phone line stopped working or the times my computer crashed. It’s making me worked up just thinking about it!
Weekend gap risk (or market closures)
For forex trading the only period when the market is closed is the weekend. That means that you can’t get in or out of positions during that time. There’s a serious risk that some news or event will occur during the closed period that changes the perception of price for a forex pair. This may leave you no opportunity to respond and mitigate full exposure to the risk.
We need to take risk to make money so it’s not necessarily appropriate to avoid these times. It’s about weighing up the market closure risk in relation to your forex trading system(s) and deciding whether the risk is appropriate to take. For some styles of trading the risk of ruin from the potential weekend gap will be too high.
Risk of economic news
Trading through economic news events can expose a forex trader to higher than usual gaps and slippage. This can cause a trader to lose more than their planned risk. It’s important for a forex trader to weigh up the potential impact of risks of different types of news events and decide whether any specific action is required to lessen the higher risk.
Risk of slippage
Some slippage is a normal part of trading on a live account. We don’t always get filled at the exact price we ask for, most especially with variances on a fifth decimal. Then there are other sorts of excessive slippage that we influence to some degree by the decisions we make with how we choose to trade during times of economic news and market closures.
A forex trader should allow for the average degree of normal slippage when they work out their position sizing. This is so that the trader’s actual risk per trade is what they’ve pre-determined.
Risk of your own knowledge and skills
If you’re a beginning forex trader there’s a significant risk from your lack of knowledge and skills in terms of how you trade and relative to other market participants. It’s important to consider and be honest with where you’re at so that you trade a trade size appropriate for your skills. This may be less than you have available to trade.
Risk of mistakes
Every forex trader needs to be aware of the large impact that mistakes can have on their trading results. You can put in place processes and controls to safeguard yourself from mistakes. To be a consistently successful forex trader mistakes just can’t happen.
Risk of a catastrophic event
Catastrophes do happen. Sometimes they hit you directly and other times they hit our bank account and spirits. No matter what, they always shock and leave you with a little less faith in this world.
Although we can never anticipate a catastrophic event, we do influence how it affects us to some degree from a combination of the decisions we make in other areas. Will it financially ruin us or will it not? That much I like to think we have a little control over.
Get it right
As you can see there are many risks that a forex trader considers in order to develop a sustainable successful trading business.
Taking risks brings riches but not if you invite ruin in.
Resources for risk management
How To Use The Forex Factory Calendar Plus Forex Tips [Economic news]
Forex Leverage – Don’t Flush Your Trading Capital! [Broker risk]
This is lesson #3 of a 10 part series for TraderRach email subscribers. JOIN NOW to ensure you keep up with results oriented traders serious about their trading success. Don’t be left behind.
About the Author: I’m Rachel Hunter, TraderRach, a Forex Trader who helps traders achieve the life they love with forex. Be strategic and design your trading business for sustainable success and have fun! That’s my mission. Join many traders’ gaining the edge with “10 Powerful Lessons for Forex Trading Success” plus other goodies. Years of precious learning specially packaged up for you. My background before trading is as a Chartered Accountant and Chief Financial Officer. I know what it takes to make a trading business rock on. It would give me great pleasure to make a difference to your success.