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Risk Management for Forex and CFD Trading

8 minutes to read
Risk Management for Forex

Learn the best risk management practices for successful Forex and CFD trading.

In order to trade Forex and CFDs, leverage is needed, and it can greatly multiply your profits. Due to the risk associated with leverage, though, your losses can be significantly increased too. The higher the potential profit, the greater the risk, so it is a prerequisite for your subsequent trading to understand the risks of leveraged trading. Your guide to Risk Management for Forex and CFD Trading.

As we said, Forex trading does have high risk. Thankfully, in many ways, you can lessen this.

This article will guide you through the basics of applying risk management strategies. Please note that this is not financial advice, and we are merely providing an informative resource for you to educate yourself on this topic further.

What Does Risk Management Mean?

General trading risks

Your profit opportunities are always closely correlated to market risk.

Think of risk management as a package of assets and activities that you can use to keep your losses low and potentially increase your profits.

Risk management in Forex trading is based on the following four fundamentals:

  • Identifying the risks of Forex
  • The analysis and assessment of these risks
  • Solving ways to reduce the level of risk
  • Consistently using these solutions with careful management and consistent utility

Examining markets is a priority for both novice and experienced traders alike. Finding a good market “entry” is vital. However, this doesn’t lessen the value of risk management has, for professional and new traders alike.

We also wrote an article about market risk specifically click HERE to read it

Leverage effect

Most people choose Forex and CFD trading because of the possibility of leverage. Why? Because with leverage, we’re going to have a much smaller margin requirement, with less capital – this helps produce a more significant profit margin.

REMEMBER; If the market doesn’t go your way, you could lose a lot more!

The more leverage you use, the faster you can win or lose. For example, there is a chance that you could choose leverage higher than you can handle. If this were to happen, it could cause you to no longer manage your assets sufficiently, potentially causing losses. Less leverage can be an attractive option to reduce your risks, but, at the same time, any potential profits would deflate because of it. Therefore, it is worth carefully considering the degree of leverage you have.

Incorrect market valuation

Trading Forex pairs, CFDs begins by deducting spread costs (difference in buy and sell price). Immediately after opening the position, there will be a negative value in your profit column. You should be aware that your trade will not always be profitable. It doesn’t matter how much you lose. To keep losses within reasonable limits, you should set a stop loss. However, remember that setting the “stop-loss” too narrow will mean your position may be closed even with minimal market movements.

Remember, not all positions will close in the green (profitably).

Rapid market movements

The market continuously moves because of news, opinions, trends, and political decisions. 

For example:

  • Suppose a central bank announces that it is changing the interest rate. In that case, this suddenly causes considerable movements in the markets, and significant gaps (breaks) in the exchange rate may appear very quickly.
  • A prominent market participant may intentionally cause market ‘pain’, generating a significant downward shift by liquidating specific, more prominent positions.

Sometimes there may be unexpected market movements. Even if you feel like you are constantly watching what is happening, you can never know precisely what will happen in the next few minutes.

What do we suggest for that? 

You may want to use automatic tool systems, such as stop-loss and take profit parameters, to close your positions on time for you. However, it is essential to know that inputting a stop loss does not promise to eradicate the possibility of loss completely; it can only limit how much loss you can suffer.

Market gaps 

Suddenly the exchange rate jumps, which is clearly evident on the chart.

A gap usually occurs after the market closes, but there are situations when the exchange rate reacts to unexpected economic news or events in the case of an open market.

Why is this important? If such an open market gap is created, the set stop loss and take profit levels will only be executed with the closest exchange rate available. An example on the EUR/USD graph:

  • An unusually large weekend gap emerged on this chart
  • There is no bid/ask within the gap, which means that the stop loss placed is only triggered at the nearest exchange rate after the gap.
Risk Management for Forex

The presented gap on the chart shows a negative slide in Forex Trading rules. But, of course, there is also an example where slippage can result in a higher return for the client, since the profit taking has been achieved in a more favourable place.

Risk management tools

Stop loss – know your limits

Prices can move very quickly, especially if the market in a period of volatility or nervousness. Therefore, a well-placed stop loss “reacts” much faster than any manual trader would be able to react, making it one of your most serious risk management tools. 

Countless articles and articles have been written about choosing the proper stop loss, but there is no golden rule that can apply to all traders and their different trades. The appropriate stop loss location for each trade must be determined separately by answering the following questions.

  • What is your trading timeline (just know – for a longer-term position, there may be more volatility)?
  • What is the target price, and when can we expect to reach it?
  • What type of account do I have, and what balance do I have on my current account?
  • Do I currently have any open positions in the market?
  • Is my position size appropriate for my account size, balance, trading timeline, and market situation?
  • What is the general market sentiment (volatility, liquidity, news, external factors)?
  • How long is the market open (e.g. is the weekend is approaching or when will the market closing be happening in the evening)?

Since there is no general rule on setting up a stop-loss, we recommend using a free demo account so that you can learn to get to grips with proper implementation without any real risk happening to you. Here are some trading examples of different stop loss uses. If you have a real account, you can use MT4’s extended trading features in the same way, which displays the risks associated with each stop loss in the specified currency.

Position size

Even the best of traders can experience non-profitable positions. For example, ending with 5-8 out of 10 trades positive is considered a successful ratio in Forex Trading. Therefore, a well-chosen position size is critical to get through any market movement.

Select leverage

As you already know, too much leverage can increase your risk, and even a few negative trades can ruin your good results. So, we want to remind you:

  • To choose the right level of Forex leverage for you, and don’t get in over your head.
  • use our trading calculator in MT4 Supreme or on our website to see different trading situations, which will help you later choose the right position size for your live trading.

External factors

Keep in mind that several external factors can affect your trading strategy on Forex. Such factors:

  • power outage and/or internet connection problem
  • you are busy or hijacked by office work.

Try our trading calculator to practice different trade scenarios.

 (Try the trading calculator)

Be aware of the picture as a whole

Forex and CFD trading can provide substantial profit opportunities when buying or selling. But remember, it can also cause losses if you don’t practice and learn risk management. Identify your weaknesses and manage them. This will be what will help control your losses – even if you have 8-10 winning trades, just one single losing trade can absorb all of those profits.

We know that the psychological factor in a loss-making trade can discourage many novice traders. But it is essential to understand that loss is part of trading. So, before you start your first live trade, understand:

  • Losses are inevitable
  • And know how to process them psychologically before they happen.

This guide is intended to facilitate the trader’s risk management with descriptions and examples. As well as what tips we offer, we ask that you do these two things:

  • Keep this fundamental information in mind as you improve your personal risk management strategy
  • Understand that the information we have provided here will only help you to limit your losses – it will not solve them.

But listen, remember, Forex and CFD trading isn’t Heaven and Hell itself. You can significantly improve your profit/loss ratio for successful trading by selecting the correct risk management methods and applying them consistently.

You can try Forex trading risk free with a demo account. There are many brokers out there that we could recommend, one of which being Etoro.

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Top 10 Forex, Stock Market and Money Management Tips for Beginners

6 minutes to read
Top 10 forex tips

To help you better prepare for the world of Forex Trading, we have put together our top Forex money management tips, which you will find below.

As always, in order to be successful in trading, you need to have a complete, and carefully thought-out trading plan. A good trading plan will tell you when to enter a trade, when to close that trade, which currency pair to trade, and how to manage your money overall. As you can probably tell from this, the forex money management strategy is vital, but it is a small part of a much bigger picture.

Stock Market Tips – Money Management Tips

Our Stock market tips (basically investment tips) are not placed in order of weight and are equally just as important as each other. Don’t feel like you can only read through this once, if you do need to go through multiple times it doesn’t make you any less of a trader.

If you feel the need to, browse through the list several times to learn each one properly so you can then know how to best implement them into your own trading strategy. If that is what you wish to do of course!

1. Quantify your risk capital

In many respects, this is one of the keys to forex money management strategies. For example, the size of your total venture capital may be a determining function of the maximum size of your position.

You should know that within any single trade, you should never risk more than 2% of your total capital.

2. Avoid trading too aggressively

Trading too aggressively is probably the biggest mistake that beginners will make. If a shorter losing streak is enough to grind down most of your capital, it shows that you’ve taken too much risk in each trade.

One way to set yourself the right risk is to choose the size of your position based on the volatility of each pair. Remember, a very agile couple requires a smaller position than a less volatile companion.

3. Be realistic

One reason new traders are too aggressive is that their expectations are unrealistic. They believe that aggressive trading will help them get rich quickly. It’s important to always have reservations about the investment tips you read online, as what works for someone else may not work for you.

The best traders are constantly making returns on their money, however realistic goals and a more conservative approach are the right way to start trading.

money management tips

4. Admit if you’re wrong

The golden rule of trading is basically to just let your profits run and to, of course, cut your losses in time. It’s essential that you quit quickly if there’s clear evidence that you’ve entered into a bad trade. It’s a natural human instinct to try to turn a flawed situation around and change it for the better, but in FX trading this would be a huge mistake.

Why? Simply because you can’t control the market. 

5. Prepare for the worst

We don’t know the future of the markets, but there’s plenty of historical evidence. It will not be repeated again, but it shows what patterns and trends have formed over time. That’s why it’s important to also look at the past behavior of the pair you’re trading on the charts.

Think about what steps you should take to protect yourself, for example, don’t underestimate accidental price shocks. Being in a very unfavorable price move is not a misfortune – it’s a natural part of trading. So you have to have a plan for these extraordinary situations. You don’t have to go too far in the past to find an example of a price shock. In January 2015, the value of the Swiss franc increased by around 30 % against the euro in a matter of minutes.

6. Set exit points before you enter a position

Think about what goals you want to set for profit and how much of a loss you’d be willing to accept, should it go the other way. This will help maintain your discipline in the heat of trading. Also, it emboldens you to think more about the risk-return ratio.

7. Use some kind of stop loss type

Stop-losses will help keep your losses low, and they’re especially useful when you can’t keep an eye on the market all the time. If nothing else, at least use a mental stop-loss i.e. A mental note of the lowest point of loss you’d be willing to accept, at which point you no longer want to risk new trades. Price alerts can also be very useful.

You can also set up notifications for MetaTrader 4, for example

8. Don’t trade out of a sudden agitation

At some point, you might make a massive loss and even lose a significant portion of your entire capital. As we mentioned earlier, here you will be tempted to try to recover all the losses in one trade.

The problem with this though, is if you increase the risk when your capital is already in trouble, the worse the potential position that you could end up in. This is a Forex tip you should definitely take heed of.

Instead, reduce your exposure to losing positions or wait a while until you find a really clear new sign. Always stay in balance, both mentally and in terms of the size of your positions – this perhaps one of the most important tips on Forex money management strategies.

9. Respect and understand leverage

Leverage allows you to take a much larger position than your true capital would allow, but of course it also increases your potential risk in the same way. It is very important to understand the size of your total exposure.

10. Think long term

It goes without saying that the success or failure of a trading system will manifest itself more so in the long run than it will in the short term. With this in mind, be careful not to attach too much importance to the success or loss of a trade. Don’t make exceptions by changing or ignoring the rules of your usual system just to make sure your current trade is going well.

Whilst reading our Forex, Money Management and Stock Market Tips for Beginners please bear in mind that, Like all aspects of trading, the acceptance of investment tips purely depends on the preferences of the individual. However, when presenting the above stock market tips, we tried to be able to advise in such a way that would be found useful by a wide range of traders.

We would also like to point out that some traders are able to endure higher risks than others. But if you’re a novice trader, no matter who you are, we recommend you start out more conservatively.

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