Forex Trading: The Best Risk Management Strategy For Individual Traders

trading the forex market is considered one of the riskiest forms of investment. As volatility is the name of the game, and because margins are huge (up to 200x), the only way to protect your trading capital is to employ a coherent Risk Management strategy.

While the trading desks of hedge funds and investment banks have to take into account several portfolio optimization procedures, as an individual operator, trading just one currency pair is often the best approach.

Thanks to strong correlation between different currency pairs, be it positive or negative, it only makes sense to focus both attention and resources on just one pair. Among other important advantages, the trader can become familiar with certain habits of a currency pair, as daily range, best time of day to trade it, or main actors.

As the primary objective of a professional forex operator is the protection of his or her trading capital, and not the profit, each trading decision must be accompanied by a comprehensive plan to protect this capital.

You have to deal with this term, protection, from a trader’s perspective, as opposed to the general understanding. In trading terms, by protecting your capital means offering you as many chances as possible to stay in the game, to live to fight another day, without being forced to close down the business. This means that you are going to lose money, as cost of business, but you have to do it in a way to continue it as long as possible.

The following example is eloquent.

We will consider an initial trading capital of 10,000 USD. As each trade has an intrinsic risk, we will use two levels here, the first at 50% and the second at 1% out of the total trading capital of 10,000 USD. This means that in the first case the operator risks to lose 5,000 USD, while in the second case, his or her risk is limited to 100 USD.

Simply put, you will never lose more than a certain percentage of your trading capital in just one trade. Be aware that even if you trade heavily margined, the percentage must refer to your trading capital and not to the position. If you open a 100,000 USD (10x) with a 10,000 USD capital, then the percentage must be applied to your 10,000 USD.

By using obvious extremes, it is quite easy to comprehend the advantages of a percentage risk management. If you lose half of the capital in just one trade and you keep this way of trading, just one more mistake will put you out of business.

On the other hand, a 1% loss is by no means dangerous for your trading capital. In addition, this gives you time to err, time to learn from your mistakes while you progress on your way of becoming proficient in this business.

The percentage varies from trader to trader, according to their “risk tolerance”. Some trade with 2%, others prefer a more aggressive 5%, but the overwhelming majority NEVER risks more than 10% in just one trade.

Along with a trading plan with specific entry and exit levels, both for profit as well as loss and maximum time in a trade, this percentage rule is a powerful tool for protecting your trading capital.

Bogdan VASILE

Professional FOREX trader and owner of FOREX education website Forex-Arena.com

www.forex-arena.com

headoffice@forex-arena.com

Mr. VASILE is the founder and President of VORTEX Capital Management, a seasoned FOREX trader, member of the Securities & Investment Institute in London and author of the revolutionary SyncronDec™ training program used in his professional FOREX course. He is also the owner of http://www.forex-arena.com, a professional website, dedicated to FOREX analysis and education.