“Oh, you trade? I would never trade, it’s TOO risky!”
“You could lose all your money trading.”
“I blew up an account trying to learn how to trade!”
These phrases and sentiments are quite common when the topic of forex trading risk is discussed. Any time that I hear one of those phrases, I promptly agree. It IS a risky endeavor. However, I quickly add that where there is risk, there is reward! IF you can identify your trading risk, you can plan for it and even control it.
Identifying Risk
Let’s identify the risk in the trading world, because if we can identify it, we can manage it. It’s quite simple, really. In order to make money in the markets, you need to risk money. So, one of the risks in trading is losing money!
It’s difficult to lose money even if one has it in abundance, the risk of losing money can be the biggest obstacle to overcome for traders who do not have a lot of it. This is not an easy obstacle to overcome emotionally, but it is possible. You want to be able to recognize and identify how much a lost trade affects you. It can be overcome.
I like to share a story about the first trade I took in my live account. I paper-traded for a year and had done really well, so I thought that trading would be easy and smooth sailing. After I scrounged up around $11,000, I placed my first trade. Can you guess what happened? No, I didn’t blow up the account that’s most traders’ first guess, I lost $200. Less than 2% of my account. Not bad, very reasonable loss.
Well, not to me, I bawled like a baby on the drive home.
The emotional impact was strong. I’ve had lost trades plenty of times in my demo account, but losing REAL money, that was not something I was prepared for.
Luckily, because I had identified my risk for the trading strategy, I was able to follow those risk rules and mitigate some forex trading risk! Still, I stuck with it and have learned how to manage those emotions.
Planning Risk
This brings me to the next point. I have learned how to manage risk by planning for it. In a previous blog, I mentioned how risk management is essentially pain management and that you can decide how much pain you feel when you take a loss on a trade. This only happens before you’re in a trade. You cannot and should not be planning your risk on a trade if you are already in the trade.
There is a saying by pilots that relates to trading. “It is better to be on the ground wishing you were in the air than it is to be in the air wishing you were on the ground.” As a trader, there is nothing worse than being in a trade not knowing how you’re going to get out of it. If you don’t have a plan as to where your stop (or your take profit) is on a trade before you even enter the trade, then you’re not properly planning your risk. And if you’re not pre-planning the risk of your trade…
…then you have no business being in this business.
Seriously, you’re just gambling if you don’t plan your risk beforehand. And gambling traders are not successful traders in the long term.
So, what does the plan look like?
Based on practice and demo account stats you should be able to determine what percentage (%) risk or dollar ($) risk that you can afford to lose or your account can afford to lose. Use your trading stats to determine a reasonable amount to risk but still maintain your capital in the event of a series of uninterrupted losses and avoid major drawdowns.
A good rule of thumb is 1- 2% risk per trade if you don’t know where to start. If you put this in your trade plan, and you follow your risk, you automatically put yourself in a better probability of becoming a successful trader.
Controlling Risk
Part of controlling risk is controlling yourself. Remember my crying all the way home after losing the money story? I controlled my risk well enough, losing only a small percentage of my account value, just under 2%. But what about my emotions?
managing emotions is much easier said than done, isn’t it? But in trading it IS essential. It is critical. You can have the best risk plan, the best risk rules, the best strategy for your trading but without a handle on your emotions, just throw all of it out the window. You likely won’t follow it 100% of the time.
Some say that automated trading is best because it takes away all the emotions from trading. I wish that were true. You see, you can still lose money in trading with automated trading, and losing the money is what ties your emotions to it. Learning to manage your emotions is the missing component of most trader’s ability to control the forex trading risk.
Why? Because another risk to your trading is yourself. So, learning to control yourself, your trading habits and behaviors, your emotions, will help you to manage and control your risk!
The practical outlook of controlling your actual risk of your trading capital is to stay consistent with the execution of your risk plan. This is why everything else talked about above is so important, because without those in place, trying to control your risk won’t work.
Managing Forex Trading Risk in Your Next Trade
Identifying your risk, planning your risk and controlling your risk is a juggling act and it is not one that is easy to learn. But with deliberate concentration and practice, you can learn to juggle identifying, planning and controlling your forex trading risk so it becomes second nature.
Going forward, create a list of:
- Risk factors that you believe will affect your next trade.
- How you can be proactive in preventing the risk factors.
- How you can make sure that these risk factors don’t affect your next trade.
