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Importance Of Risk Management In Forex Trading

by Louise W. Rice
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One of the most crucial topics when it comes to trading in the foreign exchange market is the issue of managing risks during trade —or simply, risk management. Forex trading is a viable venture where lots of profits could be made. However, you could also lose a part or even all of your capital if care is not taken. The care you need to take in forex trading is risk management.

Ironically, risk management is one of the most neglected lessons in forex trading. This oversight is caused by a variety of reasons, including a lack of understanding leverage to flat-out greed. Sometimes, some traders are impacted by their excitement and make mistakes when trading.

Thankfully, avoiding these mistakes is possible when you have a comprehensive plan on how you trade in the forex market. This article, therefore, seeks to highlight the importance of risk management in forex trading. However, we need to understand the basic concepts of this topic.

What is Risk Management?

Risk is termed as being “the prospects for the returns on an investment to be lower than the expected return.” In other words, it is the possibility of suffering a capital loss rather than a gain.

Risk management, therefore, is defined as the guidelines and measures that one puts in place to ensure that the impact of any perceived loss is manageable. Risk management strategies help you to minimize the chances of economic and financial ruin from the risks you take.

This is particularly important because forex deals largely with numbers and involves a lot of risks. And, with retail forex brokers like Mtrading, trading forex from home has never been easier. However, the ease of trading from the comfort that these platforms provide does not make forex trading a child’s play. It’s a risky venture and as such, proper care must be taken.

Risks of Forex Trading

There are several risks associated with forex trading. They include:

1. Currency risk

This type of risk is associated with the typical fluctuation of prices that occurs within the market, causing foreign assets to either be more or less expensive.

2. Interest rate risk

Interest rate risk, on the other hand, is the type of risk that comes with the sudden increase or decrease of interest rates. This volatility can affect forex prices, because the level of spending and investment can increase or decrease, depending on the direction changes in the rate.

3. Liquidity risk

This type of risk occurs when you are not able to either buy or sell assets quickly to prevent such loss. The forex market is known for its liquidity. However, there are also periods of illiquidity that can be caused by a variety of factors. Such factors include currency and government policies.

4. Leverage Risk

Finally, leverage risk is the risk of magnified loss when you trade on margin.

Importance of Risk Management

Forex trading usually boils down to three essential factors:

  • Your currency pair;
  • Your win-to-lose ratio and;
  • Your limitations.

Here’s how risk management can help mitigate these factors:

1. Risk management helps you to understand your currency pair

Having a proper understanding of your risk strategies will help to broaden your knowledge of the foreign exchange market and make critical decisions when trading in the market.

This is because your trading activity should be hinged on data and adequate research, not intuition and luck. Therefore, risk management is important because it helps you —the trader— to understand that knowledge is an essential part of the trade, and therefore, you make decisions based on historical charts and research, rather than intuition, sentiments, and sometimes, luck.

2. Risk management helps you to understand your limitations

It is important for you as a trader to understand your limits when it comes to opening and closing positions.

For instance, it is conventional knowledge that professional traders never risk more than 3% of their entire capital in a single trade. How do you do this? You need to thoroughly understand risk management strategies to stop you from making intuitive and rash decisions.

3. Risk Management will help you set a win-to-lose ratio

As a trader, it is pertinent to have more wins than losses to succeed long-term in the financial markets. But for this to happen, you must have a risk management strategy that continues to prove useful to you over time, because the goal is to minimize risk while maximizing your profits.

Risk Management Strategies

There are certain steps to take when assessing risk. These include:

  • Identify the risk: First, it is necessary to identify any risk that can cause potential problems or even benefits. Risk can either be internal or external.
  • Evaluation of the risk: The next step is assigning a particular quality to the prospects of results on every risk you take. This helps to put things into perspective for you as a trader, as you can determine the extent of each risk.
  • Treat the risk: Having assessed the risks involved, you then manage the risks starting from the most potent one.

Conclusion

In conclusion, trading in the forex market requires a lot of dedication to the craft, grit, and sometimes —luck. But it is easier to narrow your chances of making any impactful loss when you utilize proper risk management strategies. When evaluating your risk management strategies, you should do so irrespective of sentiments and emotions. Mtrading also offers certain trading strategies, such as copy trading, that also significantly affect your risk management strategies.

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