All trades on the foreign exchange market come with a degree of risk with no trade guaranteeing profitable outcomes. In fact, approximately 90% of all foreign exchange traders experience a minimum of one detrimental loss during their forex trading career. This being the case, success is measured not by profits gained but by reduced losses. One method of reducing these losses is via risk management techniques.
Controlling your foreign exchange rate trading capital
The foreign exchange market is one of the most volatile of all financial markets with profits turning to losses in a matter of minutes. To survive on this market you must ensure you are managing your foreign exchange rate trading capital correctly.
One of the primary rules when trading on the market is to not trade with money you cannot afford to lose. The rule of thumb is to never trade more than 2% of your current trading account balance, even if this means trading as low as 10 pips at a time. This may seem low, but if you are opening multiple positions at 10 pips each the overall potential profit can be considerable.
There are traders who choose to ignore this rule and risk more capital than they can afford to lose. In many cases this is seen among new traders who are trading with leverage. Leverage is used as a means of trading large positions on small amounts of capital, and can be highly beneficial if the trade is profitable. However, if the trade turns bad the loss can be more damaging than if leverage had not been used.
Using foreign exchange rate trailing stops
There are two well-known and frequently used types of stops seen in the foreign exchange market – the stop loss order and the trailing stop. The stop loss order will prevent the loss experienced in a bad trade drop to unnecessarily damaging levels. However, this article is examining risk management techniques used to protect profits; therefore, the trailing stop will be examined in more detail.
The trailing stop order is one of the most effective methods of protecting a foreign exchange rate trading profit. The key to using a trailing stop is to set a near-term profit target. For example, if your near-term profit target lies at 10 pips then you should move your stop to breakeven as soon as the target is reached. If it moves lower and takes out your stop you should consider the trade a scratch as no profits or losses will be experienced.
Trading the foreign exchange rate in lots
Another method of protecting any profits gained involves trading multiple lots. For example, if you are trading two lots then you will have two separate profit targets. The first target may be placed at a position closer to your entry price, whereas the second lot may be placed much further away. Once the first target is reached you should move your trailing stop to breakeven protecting the profit.