RISK AND MONEYMANAGEMENT
Risk and money management is the act of managing your capital to trade in such a way that even if there are times of loses in your trading you are still in business. You can have a good strategy as I have shared with you in this book, if you don’t have a good money management, you will soon blow your account or just breaking even, even if you do at all. I must let you know that good money management with a trade plan is like the driver that will drives you to your destination in the Forex business. Lose it, and you are inviting your exit out of the business very soon.
Risk in forex trading
After you have found a valid and tradable signal, the next thing you need to calculate is your risk. How much am I risking in this trade? How much will I profit from this trade? This should be the next agenda you need to sort out before you place your trade.
It is a common slogan in Forex business that don’t risk more than 2-3% of your capital. While this philosophy is good, I believe how much you risk has to do with the personality of the trader. Assuming we have 5 different traders each with a capital of $1000. Some can conveniently lose $100 in all their trades combine without affecting their emotions, while some cannot afford that large loss. They are okay with $50 or less on $1000 capital.
In my own trading style, I am okay with 10% of my capital. That is my risk for any volume of trade I take. But don’t risk more than 10% at most. You can start with 2-3% of your capital. Look at a percentage of your capital that when the trade goes against you, you wont bite your finger and get depressed. If 2% or 3% or 5% is okay with you stick with it. Find what works for you and stick with it.
For instance if am trading with $1000 capital. I am comfortable with $100 risk per trade. It may not be in one trade alone, assuming I am trading 2 pairs; I will have to use the position sizing to determine the lot size to trade in each trade so as not lose more than $100 in both trades assuming it goes against me. And if it is just one trade, the maximum am comfortable losing is $100.
The essence of staying with a comfortable risk – money management is to ensure you are in business even if you have series of losses consistently. Now assuming I have $1000 capital and my maximum risk is 3%. This means if I lose per trade, I am okay with $30. Now with 3% risk per trade, assuming I keep losing in each trade. I will have to lose 33 times before I blown my capital. If I use 10% maximum risk, I will have to keep losing for up to 10 times consecutively before I blown $1000 account.
This understanding must be factor in when you are trading so that you don’t just take any lot size whenever you want to trade. But the good news is that with a good trading strategy like the ones I shared with you in the previous chapters. It is impossible to lose consistently in a row except you are not doing the right thing.
If you are trading Pin Bar alone. (Back chart and count the number of times Pin Bar formed on the chart for a given time period). You will discover that even if it does not work, maybe at most 3 trades out of 10 trades. That means if you are risking $30 per trade. And your reward is $30. The total of 10 trades is $30 x 10 = $300 while your total loses is $30 x 3 = $90. Your profit at the end of your total trades will be $210. It could be more than this provided you are getting a reward of twice of your risk.
Once you factor in your risk. The next thing to look for is your Reward. Reward is how much this trade will give me back in profit if it works. I am risking $30, will I be able to get up to $60 or more than what am risking? The most acceptable risk-reward ratio is 1:2. That means find out if the trade will give you up to twice the amount you are risking. Sometimes you may not get up to that. Maybe 1:1 or 1:1.5 but is better if you can get at least 1:1.5 risk-reward ratio.
Let look at this scenario. I have a starting capital of $1000. My risk is 10% which is $100. In a month if the total number of trades I am able to trade is 10. The risk-reward ratio is 1:2 that means for every risk of $100, I get $200 back in profit.
Now out of 10 trades. I won 5 and lost 5 trades. 5 successful trades will give me $200 x 5 =$1000 (For every successful trade with a risk of $100 I get $200 back in profit)
5 Unsuccessful trades will give me $100 x 5 = $500 My total profitable trade is $1000, while my loss is $500. At the end of the month, I will have $500 profit added to my capital or equity.
Now imagine if the risk-reward ratio is 1:1. That means for each successful trade, I will get $100 back in profit for risking $100. With the same total number of loses and wins. 5 successful trade will earn me $500 while,
5 unsuccessful trades will earn me $500 as well. At the end of the month, I will just break even. No profit no loss.
We are in Forex business to profit not to just break even. It is very necessary and vital to always look for a trade that will earn you much more than what you are risking per trade. This is why a good risk-reward ratio of 1:2 or 1:1.5 will still make you profit at the end of the month than just risking your money for every 1:1 risk-reward trade you see.