Friday, December 11, 2009

Currency Trading Methods

Risk Management : I would like to continue the dialogue on ways to find the right trading strategy for Forex trading. Previously, I shared that for any Forex trading methodology to be considered, it has got to be a total technique ( insert link to prior article ) .

Today, I need to add to that by talking about risk management. This is maybe the area where 95% of Forex traders screw up and lose cash. Managing risk is about reducing your losses AND about protecting trade capital by employing specific strategies to accomplish each of these simultaneously.

What do I mean by that and why is it important?

First, most Forex traders make simple trading mistakes: they take too large of a position and expose themselves to serious and steep losses should the markets move against them. Second, they fail to protect their ENTIRE account by allowing ONE trade to put their full account balance at risk.

Here's a quick and perhaps extreme example:

Suppose a forex trader has a ,000 account balance. The foreign exchange trader takes a five standard lot forex trade on the EUR/USD pair. The forex trader now has at least ,000 'margin' at risk (or 50% or more of the forex trader's account balance).

For every 1 point that this forex trade moves against the forex trader, the trader loses 1/2% of the total account balance. Find out more see this Forex Income Engine 2.0 Report. At first glance, that may not seem like a steep loss. However, should the Forex trade move a total of fifty pips against the Forex trader , and the trader afterwards exits the position, the currency exchange trader 's total loss would be an INCREDIBLE ,500! ( 25% of the trader 's account balance ). This is poor risk management and it often leads to finish wipeouts of Forex trading accounts.

How did we figure out that loss? One pip for the EUR/USD pair is the same as ( on the standard lot trade ). A fifty pip loss equals a financial loss of 0 ; and remember our example currency exchange trader had traded five standard lots -- for a gigantic loss of ,500!

Instead, any trading technique should teach you highly specific rules for incorporating money management and risk management into each foreign exchange trade you take. Find out more see my Forex Income Engine Review.

Money Management should involve the distribution of a forex account among the various trades a forex trader takes. For instance, foreign exchange traders should never trade their complete account on a single trade, and should seldom have more than some open positions. By using multiple positions, the foreign exchange trader distributes the chance among every one of the foreign exchange trades they have taken.

Risk management should involve the maximum risk in any SINGLE Forex trade, and should limit the impact of a losing Forex trade on the trader 's account balance.

Here are 2 fast examples:

Money Management : A unproven foreign exchange trader takes four separate one lot trades on 4 separate pairs. Assuming here that each of the pairs have a pip value of on a standard lot, then the total amount of the account being margined across all four trades is about 40% (it may be higher depending upon the actual pairs traded. With correct stop loss management in association with risk management, it is Doubtful the currency exchange trader would attract a complete 40% loss.

Carrying forward to chance management : In each one of the unproven currency exchange trades above, the foreign exchange trader risks only 2% of the trader 's total account balance on each foreign exchange trade. That suggests a maximum loss of 0 per foreign exchange pair traded if ALL FOUR trades are stopped out. Total loss in this situation would be 0 -- a way more recoverable eventuality than the 00 in the 1st currency exchange trade example.

Furthermore, Risk Management has the capacity to make loss recovery less complicated. For example, in the first case, where the Forex trader lost 00, the trader would need a nearly 250% gain on their next trade to recover the lost value on the first trade.

In the second example, however, the forex trader would need only an 8% gain.

A second part of Risk Management not typically discussed in poor trading methods is protecting gains. Though this starts as a consultation on Exit Technique rules, it's also a factor of risk management. Once a forex trade turns profitable, it is imperative that the forex trader manage the gains with smart stop loss management. The worst thing a foreign exchange trader can do is permit a moneymaking position to reverse and become a losing position. Thus, managing risk extends to the protection of gains on a forex trade, just as it does protecting against deep losses on a forex trade.

Therefore, in considering any trading method for use in your Forex trading, you must ensure that risk management is not only discussed, but clearly explained in conjunction with the use of the trading method. If risk management isn't present, confusing, or not particular to the trading technique, you need to avoid using that trading method. For additional info see read my Forex Income Engine 2 Review.

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