Managing Your Risk - How to Trade FOREX Safely and Profitably

Managing your risk is a vitally important element of any successful FOREX trading strategy. As part of your trading plan, risk management drives all the other elements. It determines what kind of trading style you will have, the amount of money in your trading pot, how much money you risk for each trade and much more.

Let's go through all the elements of your risk management plan.

Trading Pot

The first element is how much money you should be in your trading pot. The trading pot is an amount of money that you have allocated to trade.

The first rule of a trading pot is don't trade with money you cannot afford to lose. Don't trade with your mortgage, rent, food money! It's bad news. If you are stressed whilst trading then you are more likely to make mistakes.

The second rule of a trading pot is to decide upon a percentage of your cash wealth to allocate and stick to that percentage. At the beginning, please do not use more than 5% of your cash wealth because you will make mistakes at the beginning as you learn.

The third rule of a trading pot, is never ever borrow money for your trading pot. Once again this leads to stress and stress leads to mistakes.

The fourth rule of the trading pot, is if you blow your trading pot up (i.e. lose all your money), don't use more of your existing money. Go away and make some money from another source to replace what you lost and then trade again.

These rules are very strict for a reason. They are there to protect you!

As you gain more experience and become successful then you may be able to relax some of the rules.

Trading Style

There are many trading styles out there which are normally distinguished by the time frame you are working from. Some traders like to watch their screens all day and trade in very short time frames of minutes. They will normally trade a tick (shows every change in the price) chart, a 1 minute chart or a 5 minute chart.

Other traders will trade on a 15 minute or 1 hour chart. These traders are trading intra-day but would normally close their positions by the end of the day.

A different group of traders use 4 hour and daily charts. These traders open positions and can keep them open for days at a time.

Then finally there are the long term traders who keep positions open for weeks, months and even years. These tend to be the fund managers and they will be looking at weekly, monthly and yearly charts.

As a beginner trading FOREX it is very important that you only trade the higher timeframes first. The daily chart is the best place to start, and once you are consistently profitable on this time frame then you can try other smaller time frames.

The lower time frames are higher risk because they are fast moving, more erratic and require more experience to trade.

Practice Makes Perfect

As part of your risk management plan you need to familiarise yourself with the tools of trading and to do this you have to practice.

DO NOT PRACTICE with REAL money!

You don't need to risk any money at all when you are learning to trade. Those wonderful FOREX brokers provide you with PRACTICE accounts where you can use all the same tools for trading the markets as you would trading with real money.

So use it!

Practice! Practice! Practice!

How Much Money Do I Trade Each Time?

So you have allocated money for your trading pot and you have sent the money to the broker and you are ready to trade.

How much money should you place on each trade?

If you're a beginner at FOREX then you should risk no more than 2% of your trading pot on any one trade. The way to ensure this is to use STOP LOSSES.

The trading platform provided by brokers will allow you to set up a "stop loss" for your trade. This facility tells the broker to exit a trade after you have made a loss of X amount on your account.

You define X as a percentage of your trading pot and apply it as a price that you want to exit your trade at. If the trade goes against you then your trade will automatically be closed at this threshold that you have defined.

Now, one thing to point our, when the broker executes the "stop loss" they may not necessarily get you out at the exact point that your specified. This normally depends upon how volatile the market is at the time.

Remember that for every trade you make there has to be someone on the other side to take the trade. In a volatile market sometimes it can take longer to close the trade.

Some brokers provide a guaranteed "stop loss" but they will charge extra fees for this facility.

All the points mentioned above are very important in managing your risk and by utilising these ideas you will protect your trading and increase your profits.

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