An Introduction to Risk Management

DailyFX

Talking Points:

  • All traders need to master Risk Management
  • Margin & Leverage can affect your total loss
  • Plan your stops using Risk / Reward ratios

A trader will learn many things in their career, but no lesson is as important to master as risk management. Understanding and managing risk will ultimately affect how much we loose on any specific position in the event that the market moves against an open order. In today’s lesson we will being looking at some key components to understand when it comes to managing risk.

Margin & Leverage

Margin and leverage are two important concepts every Forex trader must know. Forex is traded on margin meaning money must be put aside to hold open your trade. As the margin requirement is smaller than the actual trade size traders can leverage much larger position than what you may have on deposit in your account balance. While leverage can increase your profits, It can also compound your losses!

Normally it is recommended to use no more than 10 to 1 effective leverage as shown below. To learn more about this equation and how to manage margin and leverage read more at the FXCM University below.

Learn about margin and leverage HERE!

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Setting Stops

For most traders, the majority of the emphasis of a trading plan is set on the market entry. However, equal if not more emphasis should be placed on setting stop orders. This order type is designed to execute in the event that a position moves against you. Traders should familiarize themselves with this order and how to place them.

Typically stops are set above a key line or resistance or below a key point of support. Once they are found they can even be coupled with your trade size to extrapolate your total risk in absolute dollars!

Learn more about Setting Stop orders HERE!

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Risk Reward Ratios

Risk reward ratios compare the amount a trader can potentially earn on a successful trade, relative to the risk to do so. One easy way to find this value is to evaluate the difference between the stop and limit on a specific trade setup. These values are important because regardless of the strategy used, traders should look to capitalize on winning positions, while cutting their losses as quickly as possible

Knowing this, traders should always look to maximize their profit potential through the use of a positive risk reward ratio. This will help traders avoid “The Traders Number one Mistake”.

Learn to set Stops and Limits with this video at the DailyFX University!

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Money Management Tools

To help traders control and manage the components of risk mentioned above, programmers at FXCM have created a simple indicator to help decipher how much risk is being assumed on any one particular trade. Once added to Marketscope 2.0, the FXCM Risk Calculator, as depicted above, has the ability to help a trader calculate risk based off of trade size and stop levels.

We walk through the download of the application, as well as continue our risk management training through a series of videos embedded into the brainshark medium. After clicking on the link below, you’ll be asked to input information into the ‘Guestbook,’ after which you’ll be met with a series of risk management videos along with download instructions for the FXCM Risk Calculator.

Risk Management App Download and Review via Brainshark

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---Written by Walker England, Trading Instructor

To contact Walker, email wengland@fxcm.com. Follow me on Twitter at @WEnglandFX.

To be added to Walker’s e-mail distribution list, CLICK HEREand enter in your email information

New to the FX market? Save hours in figuring out what FOREX trading is all about. Take this free 20 minute “New to FX” course presented by DailyFX Education. In the course, you will learn about the basics of a FOREX transaction, what leverage is, and how to determine an appropriate amount of leverage for your trading.

Register HERE to start your FOREX learning now!

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