Many currency traders find it hard to follow simple risk management rules. Many times, they will turn winning positions into losing ones. They will be surprised to find solid trading strategies result in losses instead of profit.
Regardless of how intelligent and knowledgeable, a forex trader maybe about the markets, their own psychology and emotions will cause them to lose money many a times. What can be the most likely cause? Are the markets so enigmatic and unpredictable that only a few succeed in making profit?
Actually the likely cause is that there are common mistakes that many traders commit in their trading. The good thing is that the problem while it can be emotionally and psychologically challenging can be grasped and solved.
Most traders lose money because they fail to understand and apply risk management rules in their trading methods. Risk management means knowing how much you are willing to risk and how much you are looking to gain in a trade.
Without understanding risk management, many traders hold onto a losing position for a long time and take profit on a winning position far too early. The net result is that traders end up with more winning positions than losing positions. But their account Profit/Loss (P/L) is negative. Keep these simple risk management rules in mind while you trade.
As a trader you should establish a risk reward ratio for every trade that you place. In simple words, you should have an idea of how much you are willing to lose and how much you expect to gain in a trade. A general rule is that your risk/reward ratio should not be less than 1:2. Having a solid risk/reward ratio ensures that you dont enter into a trade that is not worth the risk.
Use stop loss order to limit the maximum loss that you are willing to accept in a trade. Using stop loss helps you avoid the worst case scenario; you have many winning trades on your side but a single loss occurs that is large enough to wipe out all your profits in the account. Using trailing stops in your trading can be good idea.
There are two ways to place the stop loss order. 1) Initially place the stop loss at a reasonable level. 2) Trail the stop meaning move it forward towards profitability as the trade progresses.
There are two recommended methods of placing the stop loss order. One method involves placing the stop loss order 10 pips below the two days low of the currency pair price. For example, suppose the EUR/USD pair recent low was 1.1300. The previous day low was 1.1200. Then place the stop loss at 1.1190, 10 pips below the two day low if you want to go long.
Another volatility based method is to use the Parabolic SAR indicator. It is found on most of the charting software provided freely by your broker. Parabolic SAR is a volatility based indicator. It displays a small dot at the point on the chart where you should place the stop loss.
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