Managing Risk in Forex

Thursday, March 1, 2012
How much is too much to risk on a Forex trade? A lot of beginners don’t hesitate to risk a huge percentage of their bankroll on a trade — after all, one of the reasons that many new traders turn to the FX market is that they are able to control more money than they actually have using leverage. The reality though is that professional traders usually risk only a tiny percentage of their bankroll. Even 5-10% is too much for most traders. A better percentage to aim for is 1-2.5%. Whatever percentage you do go with, you should stick with it and be consistent. The last thing you want to do is wildly risk more on some trades than others — while you may think you have a «basis» for such a decision, it’s behavior which will quickly degenerate into gambling.

Why shouldn’t you risk a lot on your trades? The bigger your drawdown, the harder it is to recover. Let’s say for example that you open a Forex account with $1,000.00 (this is barely enough to get started; and make no mistake, if you do it right with this amount it will be slow going for a while). Let’s then say that you decide that you’re going to risk 50% on your first trade. If you lose that trade, your drawdown is 50%, and you are down to $500.00. What do you have to do in order to recover? You don’t just have to win 50% of your current bankroll — that would only get you halfway there. You have to win 100% of your bankroll, another $500.00, to get back to your original $1,000.00 — and that’s before you can even start to profit again.

If on the other hand you only decide to risk 10% and you lose, you’ll be down to $900.00. You’ll need to profit by 11.1% to make up for it and get back to $1000.00. Note how much smaller that difference is than the difference between 50% and 100%? That’s not nearly as unmanageable. It’ll also take you a lot more losses to blow your account.

The single most important thing you can do to make money in Forex is not to lose it in the first place. Money lost is harder to make up than it was to lose — just look at the percentages. It’s a mathematical fact. If you take care of your account and protect the profits you have, then your profits will take care of themselves. You should always keep your focus on losing as few trades as possible, and making those losses as small as possible. Money management is one of the key ways you can accomplish this. This is why a conservative approach to Forex is far more likely to win than one which is aggressive and involves risking huge amounts of money. Forex takes time and patience, especially if you’re starting out with very little money, but that patience will pay off in the end if you stick with it.