Risk management, just like trading psychology, is a very crucial aspect of Forex trading. It keeps you on the right track and provides you consistent growth in your account.
What is Risk Management?
Risk management, in simple words, is the difference between gambling and trading. Gambling is like placing your money in something where the probabilities are against you and you are risking a lot of money for a statistical probability of an event that is not in your favor. In gambling, you cannot control the amount of money that you bet. However, in trading, we take trades that are in our favor. It is a game of probabilities not a game of certainties. We use our plan that we create prior to entering the market and stick to it throughout. In trading, we have control over our bets and the amount of money we put or don’t put in the market.
There are moments when we lose the money but if we have a better strategy, the number of losses would be much lower than the number of wins. To make it easy to understand for you, let’s use an example. Suppose we have an account of size $10,000 and we are taking 1% risk that is $ 100. If we place $10,000 in the market, the maximum we would lose would be $100. However, those who are gambling will not calculate the risk. They will simply place the amount as per their mentality or trust in their predictions.
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Similarly, in trading there are indicators and stops that can be used to make better profits and avoid risks at the same time. The risk in trading can increase in terms of amount because the more amount you have in your trading account, the higher would be the amount at risk. The size of the trade increases or decreases with your account size. Let’s suppose that your trading account has now increased to $11,000 because you have grown. Now the 1% amount would not be $100 but it would be $110. In the same way , if you have sustained a loss and the current standing of your account is at $9,000, you would not lose $100 but $90 based on 1% risk factor.
What this does is that it prevents your account from falling further. Risk management in trading allows you to safeguard your account while continuing with the trades. This is why traders recommend using the percentages rather than amounts. Amounts, let’s say $100, would be lost in case the fixed percentage of 1% is not set.
Risk management in trading and investment is not a one-off event. You should repeatedly perform the risk management to ensure that you are not losing a healthy amount of money. If your account starts draining quickly, what you can do is check what more can be done to prevent it and safeguard your amount. Remember to draw a fine line between gambling and trading. You can also make predictions by looking at the data available.