Risk Management in Forex
This might come as a shock to you. Please be ready to learn the importance of risk management in your Forex account. I’m about to show you how you can lose nearly 2/3rds of your trades and still come out a winner. That’s right, you could lose more than you win, and still be a winner. Here’s how.
The key to any investing strategy is to control your losses. While this may sound like a logical thing to you, many people get into Forex trading and throw caution to the wind. This will get many people in trouble, and possibly cause you to blow your account. Let’s take a moment and see how you could lose 2/3rds of your trades, and still come out a winner.
Defining Your Losses
Every successful Forex trader knows how much of their account they are willing to lose, before entering a trade. For this example we’re going to use an account size of $1000 USD. We are going to limit our losses to 2% per trade. This means that for any trade we take, we are not going to lose more than 2% of our account balance.
Determining The Lot Size
Once you have defined how much you are willing to lose, in percent, it’s now time to determine our lot size. Remember we’ve started this account with a $1000 USD balance. Using a position size calculator, we can determine our lot size.
As you can see on the calculator we’ve indicated our preference to lose only 2% of our account, should the trade go wrong.
You can also see that we’ve determined our Stop Loss is going to be set at 20 PIPs.
The number of PIPs on your stop loss is going to change each time you take a trade. Remember, your analysis of a trade will tell you what your stop loss is in PIPs. The position size calculator will tell you how to manage the potential loss with the proper loss size.
Note that it is very important to calculate your risk management lot size before you take the trade. Not after!
Defining the Scenario
For the purposes of this blog post, we’ve had to make things a little simpler to deal with. We are going to take 16 trades. 10 of these trades are going to be losses, while only 6 of them are winners. In a real trading account you probably won’t have 5 losses followed by 3 wins, then another 5 losses with another 3 wins. However this is how the example is going to be set up. Keep in mind that you probably won’t ever hit the same exact growth percentage on each trade. It’s certainly possible, but don’t stress if it doesn’t happen exactly like that.
Again, this is a rough example. While the numbers were calculated on the same pair for every trade, GBP/USD, the percentage of losses and gains would be universal across any Forex pair.
The Losing Streak – Risk Management in Action
Our first 5 trades are losses. After the first trade our account balance is at $980 USD. After 5 trades our account is down to $903.92 USD. Remember, that each time we take a trade our account balance (so far) has been lower. Thus 2% of the trade account is a lower number each time!
The Winning Streak
Again, keep in mind that we’ve had to make a few adjustments and generalizations to this next part. We are going to assume that you have now won 3 trades in a row. For each of those 3 trades you grew your account by 7.5%. Thus with the 6th trade you grew your account by 7.5%. After the 7th trade you grew your account another 7.5%, and same for the 8th trade.
While that may seem like a lot to gain on one trade, it’s possible. Using a profit calculator we can see that GBP/USD with a 90 PIP move, with a .09 lot size would be a $72 gain. GBP/USD is a pair that has been known to move 90 PIPs within a few days time, sometimes hours. Remember that this is an example, and your percentage gained on each trade will be different.
After your 3 winning trades, each an exact 7.5% growth, your account would be at $1,122.94 USD.
Wash, Rinse Repeat
Let’s repeat this cycle one more time. After our 8th trade we have $1,122.94 USD in our account. Upon losing our next 5 trades, at 2% per trade, we have $1,015.05 USD. While this is more than we started with, we still have 3 more winning trades to go.
On our last 3 trades we gain an additional 7.5% per trade.
After our averaged out 7.5% win on the last 3 trades, we have $1,260.99 in the account.
Risk Management Wins!
In this example we lose 10 trades, which was 62.5% of our total trades. We only won 6 of them, or 37.5%. However we gained just over 12.6% on the account during this time period.
You don’t have to win 70% or 90% of your trades to be a successful Forex trader. You need only to follow proper risk management on your account to prevent losing everything in a single trade. Remember, Forex is a long term game. It’s not something that is going to make you a millionaire in a few weeks. Many people have gone on to make a full time living with Forex trading. For them to do so they had to manage the risk on each trade.
Join IM Mastery Academy
IM is the premier online trading educational platform for Forex, Crypto, Indices and Binary Trading.
With their training videos, live sessions and trade ideas, you can become a full time trader sooner than you think!