How to Reduce the Risk of Forex Trading

Strategy of Reducing the Risk of Forex Trading

- Apportion Your Trade
One of the method to minimize the risk of forex trading is through proper money management by apportioning your trade. Your trading capital should not be an amount you cannot afford to lose. Suppose initially you decide to deposit $5000 inside your trading account, cultivate a habit of not using all the money in a single trade.

Firstly, decide on a pre-determined percentage of your trading capital that you are going to risk on a single trade and then stick to this rule always. Successful investors normally do not risk more than two to three per cent on one trade and this epitomize the strategy of preserving capital while growing one’s wealth.

A series of 10 successive losses given the two per cent rule will lead to capital reduction of 20 per cent. It is quite common to experience a string of small losses before one start to achieve profitable trades. However, this largely depends on one’s trading system and mentality. A stop-loss order can be placed based on the pre-determined percentage rule, such that you do not risk more than your apportioned amount. A stop loss or limit order will assist to minimize lossess and protect capital for the next trade.

- Understand the Technicals and Fundamentals
Another methid to reduce risk is to trade only when you see good trading opportunities and stay out when the market is choppy. A good trader does not have to trade daily. Good trading opportunities can only be identified if you have an understanding of the fundamentals and the technicals of Forex through an automated forex trading system.

For example, do you know how currencies react to inflation or interest rates? Do you understand economic fundamentals? Do you know how to tell support and resistance levels in price charts?

To avoid being overwhelmed by the amount of data out there, first learn to decide on the currency pair you would wish to begin with and then focus on the economic news and technical signals of those two currencies. The easiest pair for for new traders would be EUR/USD, which is the euro against the US dollar, since it is the most liquid currency pair in the world.

EUR/USD has a mirror effect with USD/CHF, which is the US dollar against the Swiss franc. If EUR/USD moves up, USD/CHF tends to move down, and the converse is true. This correlation makes it easier for you to have an idea of where the currency pair may be headed next.

When the fundamental and technical signals point to the same direction, this increases the likelihood that the market will go your way, especially if you had adopted good money management skills.

The real risk during forex trading lies in the failure to fully understand Forex before jumping into this money pit. It is up to the investor to exercise his or her skills and diligence to control the risks of Forex trading.

A common misconception of investing is that one must take huge risks to reap big profits. In Forex, taking minimal risks while seeking good returns forms the basic mindeset successful traders begin with in trading. Trade forex with controllable risk and risk can be reduced through know-how.

As Warren Buffet said, “Risk is not knowing what you are doing.”