Risk Management. What Is It All About!?

Feb 06, 2021

The volatile nature of the FX market, due to the changes in the capital markets, international trade, economic fundamentals, and political landscape, has made it imperative for all to take a disciplined and tested approach to managing FX risk. Prolonged periods of extreme FX movements in the past have contributed to significant volatility in traders wallets and cash flow.

Understanding the seriousness and the need for constant awareness of risk management in the game is of key importance. 

There is so much misleading information published on social media and webpages which easily creates a false reality. People create false expectations based on these get quick rich schemes/mindsets causing problems such as overtrading, over risking, over leveraging, losing their accounts and much more. 

If people were taught properly their view of the game would change. It is important to scratch the noise and focus on realistic expectations. Advertising campaigns of brokers, traders and education providers will attempt to promote trading as the easiest thing, a piece of cake causing many traders to lose their first deposit. And... yes that is the reality out there. It's important to do your due diligence and find the necessary and proper information. 

 

FOREX RISK MANAGEMENT MADE CLEAR

The currency market is an ever-changing beast and it changes on the go. As execution speed keeps improving the number of trades increases. Hence, the market differs from the one before. As such, trading strategies that used to work, may not give you the expected results. Moreover, risk management techniques that used to work may not have the same results. Therefore, one of the most significant Forex risks comes from the ever-changing nature of the currency market.

The inputs change as well. For example, monetary policy.

All traders know that changes in monetary policy move the Forex market. The way the  monetary policy is conducted changes over time. 

Let me give you the example of something so small but with a big impact.

Under Yellen’s guidance The Feds changed the way they communicate monetary policy. More precisely, they introduced press conferences after every second meeting. Effectively, every twelve weeks, a press conference with the Chairwoman/Chairman of the Fed follows the FOMC Statement. A few years ago, it didn’t exist. Now that it does, it creates massive volatility.

As a direct consequence the market changes, and the traders' expectations change as well. To push things even further, every rate hike or change in monetary policy was implemented only when a press conference followed the FOMC Statement. What does a small detail like this matter? Most people don’t expect a rate hike or cut if a press conference doesn’t follow the FOMC Statement. Period.

WHAT IS RISK MANAGEMENT AND WHY IS IT IMPORTANT

Risk management deals with understanding the factors that affect the trading account, and  positioning in such a way to diminish the trading risks. Risk management  includes establishing the correct position size, setting stop losses, giving you confidence and helping control your emotions when entering and exiting positions. There’s no holy grail. No strategy has only winning trades. Losses are part of the game. Learning to lose is a significant step forward in any Forex risk management plan. By learning how to lose, will lead to learning how to win.

Diminishing Forex risks means having a tight stop (minimize your trading loss)? No! Instead, it means to risk a proportion of the expected reward. And, the reward to outsize the risk. That’s the definition of the risk-reward ratio. When there is a higher ratio there is a better risk management plan.

AVOIDING FUNDAMENTAL RISKS

Any risk management plan starts and ends with the trader. The pillar of any strategy is the trader. Even the steepest trends have strong reversals. Such reversals make traders reassess the Forex risks. Some don’t bear the market going against them. They only think of the profits lost. The next thing you know, they close the position. Of course, the strong trend resumes shortly after.

Discipline, therefore, is vital. If you have a plan, follow it. Remorse, regrets, self-questioning and doubt all come to hound the trader. The solution comes from risk management. Never begin trading without a proper risk management plan.

Simple things like stop losses, positive risk-reward ratios, patience, planning, discipline, will overcome them in time. And, they’ll lead to success. Diversification helps too. Avoid overexposure and overtrading at all costs. Moreover, build strategies considering time as well as price. 

 

As I always say, be disciplined and trade safely.

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