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Tips to Manage Risks in the Forex Market

by Anamta bnn
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Managing risk in the forex market can be a difficult task for traders entering the forex trading market either with smaller or larger capital. Though the forex market holds an immense profit potential, but, because of its numerous risks, it can hamper the overall trading outcomes. Thus, making it necessary for the traders to understand the possible risks even before entering the trading world. Creating an effective risk management plan demands a lot of time and practice, but it is not necessary that it shield traders from the possibility of losing capital. However, it can limit the impact to a certain level. 

In this guide, we will discuss different types of risks in the forex market and explore ways to minimize the loss because of these risks.

Risks in Forex Market

Before preparing effective trading strategies, it is crucial to understand all types of potential risks that can hamper trading outcomes. Some of the risks in forex market are:

  • Market Risks: This involves the risk associated with overall market performance, i.e., if the market is going to perform as per the anticipation or not. This risk may arise because of various factors with the prominent being the fluctuation in currency prices that makes the prices of the currency more or less expensive for buying a specific asset.
  • Leverage Risks: Usually, traders use the leverage offered by brokers to open trades larger than the capital deposited. With leverage, the traders can amplify their chances to gain profits but at the time of losses, the amount can exceed their initial investment.
  • Interest Rate Risk: This risk is associated with sudden changes, be it an increase or decrease in the interest rates. Depending on the direction of rate change, the level of spending and investment across an economy can have an unexpected impact on the forex prices.
  • Liquidity Risk: In forex, some currencies are highly liquid while others are less liquid. The currency pairs that have high liquidity can be traded quickly as there is more supply and demand for that pair while for those with lesser liquidity, the opening and closing of their trades may face a delay, leading to a situation where traders cannot execute a trade at expected prices. They may gain lesser profit or undergo a loss.
  • Risk of Ruin: The risk of investors running out of capital is called the risk of ruin. This can be understood with an example where an investor makes a long-term strategy to invest in security, but it moves in a direction opposite to what was anticipated. To handle this situation, investors need enough capital to withstand the move until the security moves in the desired direction. If they do not have enough capital, the trades could be closed automatically resulting in a loss of capital.

Risk Management in Forex Trading

To minimize the impact of the potential risks and enhance the trading experience, traders must develop effective trading strategies. This begins with a thorough forex market education, as it not only equips traders with necessary trading knowledge but also helps them to make informed investment decisions.

Here are some of the tips for traders looking to make a risk management plan in forex trading:

Understanding Your Risk Tolerance:

Trading in the Forex market is riskier. 

In the foreign exchange market, every trader has their own risk tolerance, i.e., the degree to which they are willing to endure volatility in their investment capital. This risk tolerance influences the trading approach and decision-making process of every trader. Thus, for developing a risk management plan, it is crucial to recognize and understand risk tolerance first. Initially, it is advised to risk anywhere between 1 to 5 percent of the total trading capital. However, this can be increased or decreased later depending on the comfortability of the trading system, investment goals, or income. Traders can also set their risk-reward ratio to judge the amount of capital to be traded.

Use a Stop Loss

One of the major aspects of trading in a volatile market is deciding when to enter and when to exit a particular trade before executing it. To achieve this, traders can use stops and limits:

  • Normal Stops: This allows the trader to exit a trade by closing the position automatically in case the market moves in the direction opposed to the anticipated one. Though it closes the trade, traders should know that it does not guarantee against slippage. 
  • Guaranteed Stops: With guaranteed stops, the traders can specify the price at which trade must be closed. On reaching the specified price, the trade will be closed, eliminating the slippage risk.
  • Trailing Stops: With trailing stops, the position will be closed off if the market tends to move against the anticipated direction, otherwise it will continue.

  • Limit orders: Here, traders choose a profit target. On hitting the profit target, the position will be closed. 

Manage your Emotions

When it comes to trading psychology and risk management, managing emotions is a common principle. In the fascinating trading world, most traders become emotional and fail. This is because emotions like temptation, greed, fear, doubt, and anxiety can often cloud the trader’s will to stick with the trading plan and developed strategies, resulting in poor decision-making abilities. An experienced trader understands the importance of managing these emotions and is not drawn to the fake promises of quick gains and financial freedom. 

Start with a Demo Account

A Forex demo account is a replica of a live demo account where traders can execute trades in real market scenarios but with virtual money. Within a demo account, traders can learn to trade effectively by practicing different trading strategies with different trading assets without the fear of losing actual money. Additionally, they can analyze market trends in real-time and learn the basis of forex trading while performing trades.

Conclusion

To conclude, at one end where forex offers lucrative opportunities to earn a profit, it is important to remember that it is not without its risks. However, the possible risks in forex trading can be managed through effective risk management strategies explained above. There are other ways to manage risks as well, but it is crucial to get proper information about them before applying as it can hamper your investment outcomes. Remember, you need to be aware of what you are doing, especially when you are trading with huge capital.