Forex Risk ManagementTrading Plans
Forex Risk management exists because you can always be wrong. These systems attempt to predict the future and will have a higher accuracy rate than wild guessing, but there is no 100% system. If you have a 9 wins per 1 loss win rate, your wins mean nothing if you lose your whole account when you are wrong. Risk management controls how much you can lose.
Controlling for risk also limits gain. You can earn a substantial profit if using a large trading size, but can also quickly lose a large sum of money. You do not want to over-leverage a single position and “blow your account”. The same applies for one single idea.
A single position is the same as one currency pair, while an idea-set is all positions based on central line of thought. As an example, one could say “Oil will rise, so I’m buying Crude futures, Brent Crude Futures, Middle Eastern Currencies, and the Canadian Dollar”. Those are four trades, but they are all centrally connected to oil prices rising. If oil falls all those trades could suffer losses.
You should use a maximum of 2% of your total account at risk per trade, and a maximum of 5% of your total account at risk per idea. These mean that when you exit the position, your account should have gone down a maximum of 2% per trade and a maximum of 5% per trade idea. This requires using a hard stop loss order that has been placed with your brokerage. When price hits the stop loss order, your account capital should have decreased a maximum of 2% per trade. Across all trades associated with a trade idea, it has lost a maximum of 5% of trading capital. You will always need a stop loss order.
To measure the percentage of capital lost at a stop order, use the following formulas:
If your loss is greater than 2%, you need to reduce your trade size until losses are below 2%. It can be one percent or half of one percent or anything you desire in that range. The total for all ideas based on one theme is maximum 5% lost. Add up all trades based on your idea and adjust accordingly.
You should note that stops can suffer execution “lag”. They are essentially market orders that are set at a location, so there is no guarantee they will execute at that price. Sell stops can execute at lower prices than they’re set, resulting in higher losses for a long position than anticipated. Buy stops can execute at higher prices than they’re set, resulting in higher losses for a short position than planned. This is known as slippage, and it occurs in fast moving markets.
It is also possible for stops to be skipped during weekends for FX markets, or during high volatility news releases. However, placing stops and sizing based on daily time-frames reduces the risk of high volatility news events greatly affecting your loss calculations.
You can and should also limit your margin used per trade. Essentially, take your deposited account capital, multiple that by your margin rate, and you have your total available margin. Limiting this by a certain percentage, from 2% to 5% is a good idea. To some degree, maximum loss per trade limits do this for you.
Risk Reward Ratio
The last potential limit is a structure based risk to reward restriction. You know from the technical level you shouldn’t take trades if the DPRE system has a close by Monthly, Weekly, or Daily time-frame opposing structure. This means you shouldn’t take short sale trades near a support level, or buy trades near a resist level. A risk reward requirement takes this requirement further. The distance to target should be three times the distance to the stop. The target is limited by daily, weekly, and monthly structure. If buying it is limited by a resistance, if selling it is limited by a support. This is known as a “Risk Reward Restraint”. You don’t need to close out the trade at the target, since an economic and sentiment driven trend might be strong enough to break it.
The formula for risk to reward levels are as follows:
Any result must be greater than three to take a trade. If you have a potential trade that is less than three, you let it go. This ensures your trades have enough room to justify their existence.
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