Why is a reasonable risk management important? The answer is easy: We have to learn how to manage it well in order to prevent losses. Unfortunately this is one of the most ignored themes in trading. A lot of traders are just afraid of getting right into trading with no regards to their account size. They just set how much they can lose in each single trade.
When you trade Forex you have opportunities to multiply your money but you also risk losing future profit and much more, your invested capital. Risk management techniques are used before and after opening a position. The main risk management technique is used to reduce your losses.
It is a good idea to place a protective stop-loss for every open position. The Stop-loss is a point when you leave the market in order to prevent a harmful situation. When you open a position it is recommended to use a stop-loss to protect you against extra losses.
In active trades it is important to protect your fund against a potential total loss. That is the main intention of money and risk management. Very often a new trader will be worried about incurring losing trades.
Nearly all successful trading systems include a disciplined procedure to cut losses. When a trader is down on a trade, a lot of emotions can come into play which can make it difficult to cut losses at the right time. The best exercise is to determine where losses will be cut before a trade is even opened. This will insure you of the maximum amount which you can expect to lose on the trade.
To control your invested fund well you have to determine before the opening of any trading position how much of the money you can afford to lose in case the trade goes negative. E.g. you decide that for every position your risked money will be 3%, 5% or 10% of the total fund: so you have to know before the execution of the trade the highest amount which can ever go out of your money on each trading position.
You have to calculate the following points:
E.g. your fund balance is $5000 and your predetermined stop loss pip is 50 pips (selecting the number of your stop-loss pips should be from your analytical research) and you want to risk only 2% of your fund for each position.
What do you have to do?
You should work out the 2% of $5000
Which is = $100.
Implying that you can afford to lose $100 in case of any eventuality.
Then you have to divide $100 by 50 pips
That will be $2
Your lot size has to be 1 pip to $2 which will be a lot size of 0.2.
So you have to use 0.2 as your lot size.
Always avoid to be greedy! To be less greedy means that you are able to minimize the risk.
The other main component of risk control is overall the account risk. If a trade is going against you you must have an answer for the following question: at which point will you stop and re-rate your trading system? Is it when you lost 20% of your money or 40% or 70% or when you lost the complete money? You have to evaluate your market analytical methods and see if there would be requirement for further perfection or even a change.
Also please check out if your set lot size is too large for your account size.
Risk management and fund management belong togehter. If you manage your funds well you also cut down your risk. So if you control your risk well you are also securing your funds.