Determining Your Risk Levels

Filed under: Learn Forex Trading |

Determining your risk levels is key to your success in forex trading. Risk is omnipresent in our everyday lives. From crossing the road, to eating fried chicken, we all take calculated risks on a day-to-day basis. However, most of these risks are calculated without much conscious thought. We make most of these decisions on automatic as we have digested much of the facts and can make a risk-reward decision (e.g. Does the pleasure of eating one piece of fried chicken outweigh the miniscule risk of heart disease?). In the world of forex trading, these risk-reward decisions are a much more conscious affair, at least for beginners, as we have relatively little experience with such decisions in our day-to-day lives.

 

There are several risk decisions that need to be made when trading forex. The first, and most obvious, is the maximum risk you are going to take per trade. There is a general consensus amongst professional traders that 2% (of your trading bank) is the absolute maximum risk that you should take on any one trade; with 1% or even 0.5% being safer. However, there are other risk-related decisions to be made.

 

Another decision that constantly needs to be made is the risk-reward scenario of each trade. Again, a general rule of thumb is that you should not take a trade if the potential reward is not at least two times your risk. This means that if you are risking $100 on a trade, then your target should be at least $200. However, you could have a higher risk reward than this, with three or four times your risk being very good risk-reward scenarios.

 

One final thing is whether to take some insurance when a trade moves in your favour. This could mean moving your stop to breakeven, or setting a trailing stop. Either way, both methods are good insurance against excessive risk in the markets.

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