I have commonly heard the argument that if you do not risk much you cannot gain much. This statement is very true in forex and other investment types.

However, risk management advocates for a more careful approach, one that ensures that you do not lose much and you steadily earn consistent profits.

This brings us to the question, what exactly is risk management in forex trading and what does it entail? Basically, risk management is the limiting of your risks in each forex trade in order to protect your investment from major losses.

Professional currency exchange traders always calculate the risks they face each time before they enter any trade. After calculating the risk, they will only enter a trade if the risk is acceptable.

The professionals always have a pre-determined risk level that they stick to. The acceptable risk is usually an amount that the trader feels if lost s/he can still cover the loss and continue trading with what remains.

Forex Risk Management Methods

Some of the methods used for effective risk management include trading only during particular hours, having a strict policy on taking losses, limiting trade lot sizes, and limiting leverage.

1. Stop Loss Orders

Most brokers will offer stop loss orders on their platforms free of charge though there are some who will require you to pay a subscription fee. What a stop loss order does is to close out a trade if the currency price goes worse than the trade entry level.

This is the foremost risk management tool any trader should learn to use as it automatically stops any losses from accelerating into unmanageable levels. Stop orders are easy to use and ensure that the trader only loses what they are prepared to lose, protecting the balance of his/her investments.

For instance, you may enter a EUR/USD trade at 1.3129 investing $10,000 and specifying 1.3079 as your stop level which is 50 pips below the current currency price.

The EU releases figures of rising mortgage costs and the Euro takes a 300-pip dive. Your trade will be automatically stopped at the level you indicated saving you a 250-pip loss which represents 10,000 x (0.0300 – 0.0050) = $250. Therefore, you will lose only USD 50 instead of USD 300.

However, you should beware of the fact that during periods of high market volatility, your trade could close at a different price than the one you set for your stop loss order.

This is because of gapping or slippage and is caused by a currency price jump where a currency will go from one price to another without ever trading in the prices in between. This will result in your trade being closed at the best possible trade price

2. The 2% Rule

One of the best ways to manage your risks in forex trade is to limit them. The 2% rule is an effective management technique where you do not risk more than 2% of your total forex investment in a single position.

That means that if you have $15,000 in your forex trading account, you should never risk more than $300 in a single position. Most times, this risk level is equal to 20 pips.

However, take note that this is not always so, as the amount per pip always depends on the currency pair you are trading and position size of the trade you enter.

Another factor to keep in mind is that your leverage level does not in any way affect the price per pip. You can use a pip calculator to determine the exact price per pip for your currency pair.

3. The 6% Rule

While the 2% rule states that you should not risk more than 2% of your trading account investment on one trading position, the 6% rule allows for making up to three multiple trades trading different positions.

To manage your risks successfully, you should apply the 2% and 6% rules wisely. If you enter three position and lose one of them, do not risk another two percent until that month is over.

These two rules should apply whether your forex trading investment is worth $50 or $5,000,000.

4. Leverage

Leverage can be very useful to a trader, especially one with limited capital. Leverage allows you to maximize your forex potential and earn the kinds of profit that you dreamt of when you started out as a trader.

However, this same earning potential can also bankrupt you in a very small duration of time, so you better handle it very carefully.

Figure it this way, if you take on a leverage of 100:1, you can use a deposit of $1,000 to trade up to a million dollars. In such a situation, a 1% loss in a trade wipes out your entire deposit amount!

Therefore, always make sure to limit how you use leverage to avoid such overwhelming losses.

5. Broker

To trade in the Forex market, you need a Forex broker. Making the right choice of forex broker is the most important risk management decision you will ever make for your long term forex trading success.

Here is an objective analysis of some of the best brokers in the market: https://www.forextradingbig.com/category/brokers/

If you make a wrong choice of broker, you stand to lose money consistently throughout your trading career. Apart from that, currency trading online is full of scammers and unscrupulous cons and you should do all you can to avoid them.

The first thing you ought to do is to choose a highly regulated broker. Such a broker should be one who upholds the strictest and highest trading standards coupled with financial compliance.

Before you enlist the services of any broker, weight it against these guidelines: How to choose a forex broker.

6. Risk – Reward Ratio

Every trade carries its own particular risk level. To properly manage your forex risks as a trader, you have to pre-determine your risk level before entering any trade. The most effective risk management tool in forex trading is the risk-reward ratio.

To find out what your risk is, you first have to multiply the number of lots by the price of currency traded. The reward on the other hand is the amount of currency price gain the trader hopes to attain from the currency price movement.

To be on the safe side, always set 1:2 as your minimum risk-reward ratio. Always be on the lookout for trades that show larger ratios such as 1:3 as they are likely to yield higher profits. Never trade when the risk-reward is 1:1 or less.

Summary

Attaining Forex trading success is not possible if the trader has no risk management mechanisms put in place.

Aside from the few methods mentioned above, a trader should make sure to study the fx market in-depth.

Before entering any trade, learn how to thoroughly conduct technical and fundamental analysis to avoid making losses in the first place. Once you have made your trade decision then follow the steps mentioned above.

Use the 2% and 6% rules, limit your use of leverage, and work through a regulated broker.