Risks In Forex Trading: Inevitable, But Never Unmanageable

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by: Mike Carlayle
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Date: Mon, 5 Dec 2011 Time: 10:28 AM
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In Forex trading, no matter how sure you are of the outcome of a trade, you are still making just an educated guess. If there's something definite about the currency market, it is the inherency of change, and a frequent and rapid one at that. Currency prices are influenced by a host of factors, including but not limited to market sentiments and the political and economic climate of its country of origin, and these fluctuate multiple times within the day. The ill-prepared trader can lose a big chunk of his hard-earned money in minutes. Nonetheless, even though risk is inherent in Forex trading, it is never unmanageable.

In order to manage the risk, you have to a good grasp of both fundamental and technical analysis. These disciplines help you calculate the odds of your trade being successful.

An oft-mentioned technique to mitigate losses when trading in the currency market is by adhering to the 2% rule. If that certain percentage has been lost, immediately exit the losing position. This loss-limit system can be applied even before you enter a trade by using stop-loss orders. This strategy prevents emotional decision-making like lingering on a losing position believing that the market will turn in your favor anytime soon, which often leads to further losses. Apart from mitigating losses, stop orders are likewise utilized to secure earnings.

One of the interesting features of Forex is that it is highly leveraged, far greater than other asset classes, like stocks. Leverage allows traders to control a large position for a small cash outlay. For instance, if the brokerage firm allowed you to trade at a 5% margin, you can control a lot worth USD 10,000 by paying USD 500 upfront. If the position closed at USD 11,000, you have already gained USD 1,000, which is twice the amount you used to purchase the said contract.

From this example, it is easy to see how using leverage allows one to earn significant profits. Then again, using margin to create leverage is also one of the risk magnifiers of the Forex markets. When price movements aren't as positive as you predicted, a leveraged position can erode a significant amount from your trading account. Hence, you should only use leverage when the advantage is clearly on your side, and if you know how to manage it, like using stop-loss orders. If you intend to take a hands-off approach to your trades, you should not use leverage.

About the Author

Forex trading is an excellent and exciting way to build your wealth, then again, you need to have a full grasp of risk management strategies before you make a dime. While risk is inevitable, it is still manageable. Learn Forex risk management strategies here.

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