RISK MANAGEMENT - ESSENTIAL APPROACHES FOR MAKING MONEY IN FOREX TRADING

Risk management is crucial to long-term success in Forex trading. Without appropriate risk management, a winning position may eventually turn into a loss. Lack of skills with managing trading risk is a major cause for Forex beginners' failure in trading.

What is Risk Management? Risk Management in Forex trading means identifying exposure to various market or non-market factors that might impose negative impact on trading results, and applying trading rules to minimize trading losses.

There are widely adopted approaches of risk management in Forex trading. One important rule that is generally followed in controlling the risk in Forex trading concerns the size of a trading position: Never risk more than 3 to 5 percent of your trading capital on any trade. Most Forex trading positions involve use of margin, which potentially magnifies the return on capital as well as the risk of losses. Limiting the size of trading positions can help to prevent margin calls and diversify investment.

Another approach of risk management is using proper risk/reward ratio as a criterion for determining whether to initiate a Forex position. Risk/reward ratio in trading refers to the rate between the probability of loss and profit of a trade. It is a good practice to calculate the risk/reward ratio before opening a trade. Many professional Forex traders set risk/reward ratio at 1:2 or 1:3 for initiation of a position. If a potential Forex trade does not satisfy the risk/reward criterion, it is often wiser to give up the trade opportunity.

Avoid over-trading. This applies to controlling the amount of money invested in each Forex trade, as well as staying away from trading when there are no trading opportunities.

Use appropriate protective stops. Many lessons have been learned regarding the need of using stops in trading by professional traders. Some people prefer mind stops to hard stops. The point is to determine the exit point before opening a position, whichever type of stops is used. Trailing stops could also be utilized when Forex positions are in profit.

Having a trade plan beforehand and following the trade plan can also help with risk management. Following a well-defined trade plan helps overcoming the psychological enemies of Forex trading - greed, fear, boredom, anxiety, and anger -- and protecting profits