What Makes a Trading Method “Good”?
Forex Trading Strategies : What makes a trading system “good”?
Risk Management : I need to continue the consultation on a way to find the right trading strategy for Forex trading. Formerly , I shared that for any Forex trading technique to be considered, it has got to be a total methodology ( insert link to prior article ) .
Today, I would like to add to that by talking about risk management. This is perhaps the area where 95% of Forex traders make mistakes and lose money. Handling risk is about reducing your losses AND about safeguarding trade capital by employing precise strategies to do each of these simultaneously.
What do I mean by that and why is it important?
First, most Forex traders make easy trading mistakes : they take too huge of a position and reveal themselves to major and steep losses if the markets move against them. 2nd , they fail to guard their Complete account by permitting ONE trade to put their full account balance at risk.
Here’s a fast and maybe extraordinary example:
Suppose a forex trader has a ,000 account balance. The forex trader takes a 5 standard lot forex trade on the EUR/USD pair. The currency exchange trader now has at least ,000 ‘margin’ at risk ( or 50% or more of the currency exchange trader ’s account balance ).
For each one point this foreign exchange trade moves against the foreign exchange trader , the trader loses 1/2% of the total account balance. For additional see my Forex Income Engine 2 Review. At first glance, that may not seem like a steep loss. However, should the Forex trade move a total of 50 pips against the Forex trader, and the trader subsequently exits the position, the forex trader’s total loss would be an INCREDIBLE ,500! (25% of the trader’s account balance). This is poor risk management and it often leads to finish wipeouts of Forex trading accounts.
How did we work out that loss? One pip for the EUR/USD pair equals ( on the standard lot trade ). A 50 pip loss equals a loss of 0 ; and remember our example currency exchange trader had traded five standard lots — for a gigantic loss of ,500!
Instead, any trading system should teach you very particular rules for incorporating cash management and risk management into each currency exchange trade you take. For additional info see see my Forex Income Engine Report.
Cash Management should involve the distribution of a foreign exchange account among the diverse trades a currency exchange trader takes. As an example, currency exchange traders should never trade their complete account on a single trade, and should infrequently have more than some open positions. By using multiple positions, the foreign exchange trader distributes the chance among every one of the foreign exchange trades they have taken.
Risk management should involve the maximum risk in any SINGLE Forex trade, and should limit the impact of a losing Forex trade on the trader ’s account balance.
Here are 2 fast examples:
Money Management : A unproven foreign exchange trader takes four separate one lot trades on 4 separate pairs. Assuming here that each of the pairs have a pip value of on a standard lot, then the total amount of the account being margined across all four trades is about 40% (it may be higher depending upon the actual pairs traded. With correct stop loss management, however, with risk management, it is Improbable that the currency exchange trader would encounter a complete 40% loss.
Carrying forward to chance management : In each one of the unproven foreign exchange trades above, the currency exchange trader hazards not more than 2% of the trader ’s total account balance on each currency exchange trade. That implies a maximum loss of 0 per forex pair traded if ALL FOUR trades are stopped out. Total loss in this example would be 0 — a much more recoverable eventuality than the 00 in the 1st foreign exchange trade example.
Furthermore, Risk Management has the capacity to make loss recovery simpler. As an example, in the 1st case, where the Forex trader lost 00, the trader would need a virtually 250% gain on their next trade to recover the lost value on the 1st trade.
In the second example the foreign exchange trader would need only an 8% gain.
A second part of Risk Management not generally debated in poor trading strategies is protecting gains. Though this starts as a consultation on Exit Technique rules, it’s also a factor of risk management. Once a currency exchange trade turns profitable, it is urgent the foreign exchange trader manage the gains with smart stop loss management. The worst thing a foreign exchange trader can do is permit a moneymaking position to reverse and become a losing position. Therefore , handling risk reaches to the protection of gains on a currency exchange trade, just as it does safeguarding against deep losses on a foreign exchange trade.
Therefore, in considering any trading system to be used in your Forex trading, you need to make sure that risk management isn’t just debated, but obviously explained in conjunction with the use of the trading technique. If risk management is not present, unclear, or not specific to the trading method, you should avoid using that trading method. For more see this Forex Income Engine 2.0.
