Managing Risk and Letting Your Market Edge Play Out

Filed under: Learn Forex Trading |

Screen shot 2013-03-01 at 11.04.13In order to be profitable in the forex market, you need to have a market edge – but it is not quite as simple as that. In addition to having a market edge (and finding that is no easy task to begin with!), you must also have good money management skills, and this can be a slippery customer to get hold of.

 

One of the biggest mistakes among beginner traders is to constantly adjust their risk levels. When they have a few good trades, they increase their risk, and when they have a run of bad trade, they decrease their risk. This can have a strange effect on your bottom line profit/loss figures. Let’s take a look at two examples. In the first, a trader has five successful trades in a row each with a risk-reward of 1:2, and with a 1% risk level on each trade with a $10,000 bank. This means that their bank has risen to $11,000 after these five trades. Next, the trader has five losing trades with the same 1% risk level. The bank is now back to $10,500, but the trader is still well in profit.

 

Another trader also has a bank of $10,000, beginning with the same risk levels, and after five trades they too have $11,000. They are full of confidence, and raise their risk levels to 2% per trade. They too then have five losing trades in a row, only this time; their bank is back to $10,000.

 

It is important to understand that, even though you might have a market edge, and you can expect, say, 40% of your trades to be successful with a risk-reward average of 1:2.5 (for example), the winners and the losers will not be spread out evenly – but in fact, the short-term results will be very random indeed. It is only over a very long series of results that this probability will play out, and this is what beginner traders fail to remember.

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