- All traders need to master Risk Management
- Margin & Leverage can affect your total loss
- Plan your stops using Risk / Reward ratios
A trader will learn many things in their career, but no lesson is as important to master as risk management. Understanding and managing risk will ultimately affect how much we loose on any specific position in the event that the market moves against an open order. In today’s lesson we will being looking at some key components to understand when it comes to managing risk.
Margin & Leverage
Margin and leverage are two important concepts every Forex trader must know. Forex is traded on margin meaning money must be put aside to hold open your trade. As the margin requirement is smaller than the actual trade size traders can leverage much larger position than what you may have on deposit in your account balance. While leverage can increase your profits, It can also compound your losses!
Normally it is recommended to use no more than 10 to 1 effective leverage as shown below. To learn more about this equation and how to manage margin and leverage read more at the FX University below.
For most traders, the majority of the emphasis of a trading plan is set on the market entry. However, equal if not more emphasis should be placed on setting stop orders. This order type is designed to execute in the event that a position moves against you. Traders should familiarize themselves with this order and how to place them.
Typically stops are set above a key line or resistance or below a key point of support. Once they are found they can even be coupled with your trade size to extrapolate your total risk in absolute dollars!
Risk Reward Ratios
Risk reward ratios compare the amount a trader can potentially earn on a successful trade, relative to the risk to do so. One easy way to find this value is to evaluate the difference between the stop and limit on a specific trade setup. These values are important because regardless of the strategy used, traders should look to capitalize on winning positions, while cutting their losses as quickly as possible
Knowing this, traders should always look to maximize their profit potential through the use of a positive risk reward ratio. This will help traders avoid “The Traders Number one Mistake”.
Next: Making Leverage Easier to Understand (36 of 48)
---Written by Walker England, Trading Instructor
To contact Walker, email wengland@DailyFX.com. Follow me on Twitter at @WEnglandFX.
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