How to calculate Proper Risk Management in Forex


With the pragmatic management of the initial and subsequent capital, you will be able to achieve significant success in Forex trading. However, knowledge and the ability to apply in practice the methodology of the Capital  Management  will be beneficial only if you understand the construction of trading strategies and the general principles of online trading. One of the key points of the capital management rules is considered to be an objective ratio of the volume of potential profit and probable risks. Following all the above principles, the investor will undoubtedly be able to progress and ultimately achieve significant success in this field constantly.



How to Organize Proper Risk Management in Forex

Money management in Forex fully confirms the relevance of choosing the size of pips for a particular trading opportunity, which in turn makes it possible, using additional calculations, to increase or decrease the volume of pips for all kinds of assets. The fact is that each trading strategy has both profitable periods and unprofitable segments (drawdowns), therefore, balanced control over position sizing will increase the probability of the final profit, and also reduce the risk of losing funds.

Basic principles of money management in Forex

Diversification of funds is one of the most common methods of money management in Forex, as well as on other sites. The investment strategy provides for a pragmatic division of funds into various sectors, as well as additional differentiation within different types of assets. In addition, in the context of diversification, other instruments of the foreign exchange and commodity market can be used, for example, stock indices.

A well-divided portfolio should look something like this:

1.   Low capitalization securities.

2.   Medium capitalization securities.

3.   High capitalization securities.

4.   Industry shares (up to ten sectors).

5.   Foreign securities, in our case bonds or stocks.

6.   Long positions in commodities: oil, gold, etc.


All this is necessary in order to increase the maximum protection of the trader's investment portfolio. Thus, if one of the sectors of the industry or a stock collapses, then the losses can be easily compensated for by the stable position of the remaining assets.


In addition, diversification can be used as a tool to further isolate the portfolio from ineffective money management in Forex, as well as from market risks. At the same time, the level of income will remain the same.

Regarding the principles of capital division, this aspect will largely depend on the age of the investor, investment goals, acceptable risk and amount of funds.


Three golden rules for the division of capital


1.   The amount of funds intended for opening and maintaining positions should not exceed 30% of the total capital; however, it is much more efficient to use even fewer funds, approximately 10-15% simultaneously. Remember that conservatives make much more money in Forex than fans of aggressive trading.

2.   The total amount of funds invested in a specific site, that is, the market, should not exceed 10% of the total capital. Moreover, this is still a fairly loyal indicator, many world-renowned analysts, for example, Elder, publish even tougher figures - 2%.

3.   No more than a quarter of your capital should be concentrated in one investment group. The fact is that losing trades should not cause fatal damage to your deposit; on the contrary, profitable operations should cover losses.


How to minimize risk?


In order to reduce risks, many professionals strongly recommend using stop orders in the trading process, which will reduce the likelihood of ruining a working deposit. Also, this function will allow you to increase the size of the protective order; however, a lot will also depend on the chosen trading strategy and money management methodology in Forex.

Excessively close placement of stop orders can cause unnecessary closing of a position, especially for short-term periods with strong changes in the value of an asset, and this phenomenon is also called "price noise". In turn, excessively distant stops can cause significant losses, so every trader must determine the golden mean in this matter.


Methods for Determining the Potential Profit / Loss Ratio


It is essential to understand that the procedure for managing money on Forex does not rest only on dividing funds into several parts; there are several preventive measures to minimize the final drain of the deposit. One of the most effective methods remains to calculate the potential profit/loss ratio.

  • The potential profit must be weighed against the potential loss to prevent adverse situations, usually a 2: 1 working ratio. That is, the volume of potential profit must exceed the size of the potential risks.
  • Profitable trades should be held as long as possible. First of all, this is necessary for profits to grow and thereby limit losses.
  • Volumetric stop losses must accompany the trend, so you stay in the trade while maintaining the maximum potential of the order.
  • Tight stop orders should limit short-term traders.


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