Every time you enter a trade, you risk a loss. The good news is that there are some simple techniques a trader can use to minimize his or her risk. The fundamental principles behind money and risk management are very simple. However, traders are only human (yes, indeed!), and humans are driven by emotions, which can make sticking to a trading strategy when greed or fear take over, very difficult.
One of the most important decisions when entering a trade is to know where you are going to get out of a trade if the market goes against you. One of the most effective means to do this, is to set stops ahead of time and changing these stops when appropriate.
What are stop orders?
A stop order is an order to buy or sell a currency once the price of the currency reaches a specified price, known as the stop price.
Buy Stop Order — Traders typically use a stop order when buying currency to limit a loss or protect a profit. The order is entered at a stop price that is always above the current market price.
Sell Stop Order — A sell stop order helps forex traders to avoid further losses or to protect a profit that exists if a currency price continues to drop. A stop order to sell is always placed below the current market price.
The key is discipline – traders that see a currency fall and then decide to stay in the trade lose their capital. A successful trader is an opportunist to who risks his capital with the objective of making a large profit within a small period of time. If the position turns against him or her, he cuts his losses or takes his profits immediately and moves on. A vague hope of being proved right and that the market will turn and recover may only remain a vague hope, resulting in losses.
Every trader needs to know where to place a stop-loss (covered comprehensively in module 4 of our free online training) . Every trading plan must contain a protective stop-loss. Lets look at the trading plan:
To have a trading plan, you must first take some time to get to know yourself. According to Whistler (2004), you will have to ask yourself questions such as:
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Are you driven by a trading goal?
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Are you driven by the success of the trade or by the fear of losing money?
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Does fear and greed drive you?
If you have a tendency to be greed-driven, the necessity of a money management plan with tight stops is essential to trading success. If you are driven by fear, you will close every trade that goes against you even if it is only by a few dollars. Although this means that you will never lose large amounts of capital, you will also not be able to make any real money. Every trader needs to find a middle ground. Greed driven traders need to plan tighter stops.
The key is to have predetermined stops before you enter your position. Then, you have removed yourself from the trade and is able to make more unbiased decisions regarding your trading actions.
We will assist you in drawing up your business trading plan, and we will teach you how and where to set up your stops in order to practice effective risk management. We have dedicated an entire module of our online training program to risk management.
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References:
Whistler, Mark (2004). Trading pairs: Caprturing profits and Hedging Risk with Statistical Arbirage Strategies. Wiley; New Jersey.
