INTRODUCTION_ECONOMICS_TRADING FOREX_CHARTING_RISK MANAGEMENT _GLOSSARY


RISK MANAGEMENT

Now that we have explained why and how we can place a trade, let’s take a look at the most important aspect of our daily trading procedure: Risk Management. Traders tend to be better or worse from time to time in terms of winning trades vs losing trades, but only the art of money management can make a real trading account to achieve growth.

Let’s see an example: Peter is trading daily with no money management rules, while Martin is using a stringent risk management process where he keeps at risk only 2% of his equity. Those guys are friends and they tend to trade the same currency pairs, in 100.000 USD accounts. Last Thursday they thought that EUR/USD was going up and they placed a 1 lot buy order at 1.1550. The pair went down more than 300 pips. Martin, managed to get out of this trade with his 2% risk on equity rule, losing $2.000 where Peter stuck in the trade for more than $3.400.

In this kind of situations the worst of all is the feeling or what we call trading psychology. This is what we have to keep more or less unchanged in both the upsides and the downsides of our trading accounts.
Of course, there is not only one level of risk management that we should apply to our trading accounts. Let’s see some general money management rules:

Risk Management on Equity: How much money to risk every day?
A prudent choice is a daily risk of 2% -3% of your account. So, for a $ 10.000 account the maximum risk should be settled at $300 per day. In essence, if we are losing more than $300 from the total account balance in all our trades , we should close our platform and do not continue trading for the same day. The reason behind this is that we might continue trading the markets, - frustrated about our previous losses- and trying to take our money back, which can rocket our daily drawdown to 10% or more. Then, we have to think what went wrong and try to recover on the next trading day with the same risk parameters.

Risk Management per Trade: How much should i risk per trade?
A trader is normally diversifying between 2-3 pairs, holding one or more of the majors (EUR/USD, GBP/USD, GBP/USD and others). Continuing our previous general rule of the 3% risk on equity, we have $300 to risk per trade. This means that we can trade 2-3 pairs risking $100 each. This is what we call diversification, and professional traders use to do that to balance their exposure in the market.

What lot size should I use per trade?
The size of a trade in a trading account is determined by this formula: (Money at Risk / Pips at risk) * Account. By ‘Money at Risk’ we mean the $100 that we will be risking per currency pair per day. By ‘Pips at risk’ we mean our stop loss in terms of pips (how many pips are we risking from the market price), let’s suppose 10 pips. So if we apply the numbers in the formula, the correct size that we should trade is: ($100/10)*$10.000 = $100.000 or 1 standard lot. In general, keep the rule of 10% in your mind. That means if you are trading a real account of $10.000 your standard position size will be 100K or 1 lot, if you have a trading account of $30.000 the normal trade size should be 300K or 3 lots and that goes on.

What is the best risk reward ratio?
Most of the traders try to excel their capabilities to trade the market correctly every single tie. But this is so hard. In fact you do not need more than 60-65% winning trades with proper risk management to start making good profit. But if a trader is willing to lose more than he should be making on every trade, in the long term it will very hard to keep the account growing. So for example, if we risk 10 pips (10 pips stop loss) we should be targeting 20 or 30 pips from the market. In essence, our risk reward ratio should be 1:2 or more. Our ultimate goal, is to keep our account near breakeven levels even with 40% - 50% correct choices.

How many pips should i risk?
Is there enough "space" to work with a right reward / risk ratio?
- If yes, try to "hide" the stop loss behind significant support / resistance, MA, Fibonacci points
- If not, try to change the size of the trade. So if the combination of the pips you are risking and the size of trade exceed the maximum amount of $100 per trade per day just cut your position size in half and instead of 1 lot use 0.5 lots.

When the risk management procedures are not respected, margin call comes in. But what is actually the margin call? Margin call is the order by a brokerage for an account holder to deposit more cash or securities into a margin account when the value of the cash and securities currently in it falls below some defined percentage. Every margin account has a maintenance margin requirement, which is money or securities an investor must keep in his/her margin account in order to be able to borrow from the brokerage.

FINRA requires that the maintenance margin must be at least 25% of the amount borrowed, while some brokerages require a maintenance margin of up to 50%. If the maintenance margin falls below this, the account may be subject to a margin call. If the account holder is unable to make the necessary deposit, he/she must close out enough positions in order to make the deposit, or risk the account becoming blocked.

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Risk Warning: Forex (FX) and Contracts for Difference (’CFDs’) are complex financial products that are traded on margin. Trading FX and CFDs carries a high level of risk since leverage can work both to your advantage and disadvantage. As a result, FX and CFDs may not be suitable for all investors because you may lose all your invested capital. You should not risk more than you are prepared to lose. Before deciding to trade, you need to ensure that you understand the risks involved taking into account your investment objectives and level of experience. Past performance of FX and CFDs is not a reliable indicator of future results. Most FX and CFDs have no set maturity date. Hence, a CFD position matures on the date you choose to close an existing open position. Seek independent advice.