When you get into forex trading, the first thing you get to know about the dynamic forex market is the risk that comes with the volatile nature of currencies. However, dealing with this risk is an integral and unavoidable part of trading. If you want to be rewarded with profits as a trader, you need to take some risks. But the risk should be well-calculated and managed as excess risk can become a threat to your very existence as a trader in the fast-moving forex space. So, how can you navigate the forex world within a safe zone? For that, you need to read till the end of this article as we will cover different ways to avoid taking excess risk in forex trading.
Deciding Optimal Risk Per Trade
The first and foremost thing a trader needs to decide before placing an order is their risk per trade, which is the amount of trading capital being risked for a trade. The amount you use for trading is obviously at risk of loss if your calculations turn out to be wrong and the market moves against your expectations. So, the risk per trade needs to be optimal, as risking too much in a single trade can result in an increased account drawdown.
Account drawdown in trading is the total amount that is lost from your account within a specific period. In other words, it is the amount by which your trading capital is reduced at the end of the trading process. When you take a higher risk per trade, the potential losses will also be higher, which puts you at risk of the account being blown up.
Many beginners tend to be impatient and ignorant when it comes to risk management in forex as they are too eager to make some big gains from the market. So, they take up bigger trades with a large percentage of their trading capital at risk, making them prone to huge financial losses. Newbies are lacking when it comes to knowledge, skills and experience and taking higher risk per trade will not be an ideal approach for a first-time trader.
Experts always suggest that the maximum risk per trade should be around 2% of the total capital in your trading account. Risking anything above that for a single trade would be a bad idea. Suppose you have a balance of $1000; you will only risk $20 per trade. This will greatly minimise your potential losses and limit your account drawdown. This is a win-win situation as you don’t need to be fixated on the win rate, as a couple of losses will not cause any harm to your account.
Now, let’s have a look at the calculation of risk per trade and how you can apply this concept in actual trading. The pip value is the basis for almost all trade-related calculations in the forex market, as the price movements of currency pairs are stated and measured with pips. So, you can also rely on pip value and number of pips for calculating risk per trade. Calculation of pip value can be complex for a beginner when different currencies are involved. So, you can use some automated tools like a pip calculator to make it easier, faster and more accurate.
Managing Maximum Exposure to Risk
The next method for avoiding excess risk as a forex trader is managing your risk exposure by limiting the maximum risk you will be taking at a time. This differs from risk per trade as it only tells about the maximum risk you will take with a single trade position, whereas risk exposure describes the total percentage of risk you will take with all the trades combined.
Because most traders in the currency market enter multiple trades at the same time, scalpers and day traders always place as many orders as they can to get the most out of the trading opportunities they come across. They aim to make small profits from multiple trades, which also puts them in a position where they may take excess risk.
The risk per trade will be limited to 2%, but if they enter too many trades with 2% risk, then their total risk exposure can be high, which would diminish the purpose of risk management, too. The recommended percentage for limiting your maximum exposure to risk is 5%. For instance, you could place 4 or 5 trades in total, adjusting the risk per trade in a way that only 5% of your trading capital is being used for all the trades.
You can also consider the potential profits or losses of each of these trades to determine the ideal risk for each trade. You may want to take the maximum risk per trade (2%) for the trades with higher profit potential while reducing it to 1.5% or 1% for trades with lesser profit potential. Similarly, if a trade has a higher chance of creating significant losses, you may reduce the risk to 0.5%.
Calculating potential profits/losses is time-consuming and tiring when you do it manually. The chances of errors would also be higher in manual calculations as the exchange rates in the forex market are subject to a lot of fluctuations. So, a profit calculator is the best method for calculating potential profits or losses. A forex profit calculator can accurately determine the most probable outcome of a trade within a split second. You just need to enter the required data without any mistakes and hit the calculate button to determine the potential profits or losses in a particular trade.
In some cases, you will get to know that a trade is not worthwhile as it only results in a higher risk of loss without enough profit potential. It would be better not to enter such trades as it only increases your risk without contributing towards your returns. So, make sure you find the best online tools and use them well while making trading decisions to get the desired results with minimal exposure to market risk.
Trade with Target Extension
The last tip for avoiding taking excess risk is trading with a target extension. For those who don’t know about target extension, it is actually a term related to trade setups. Target extensions are proven to be helpful in reducing the risk and improving the profitability of a trade. When a trader places an order, they will surely have an expectation for maximum profits they aim to make with this trade. This is what we refer to as a profit target.
Now, imagine a trade goes exactly the way you want it. You place an order following the trend, and it reaches your profit target, but the price continues to move in your favour as the trend is still quite strong. In such a scenario, consider extending your profit target, because trading is all about maximising your profits. Now, you may ask how it helps you in avoiding excess risk.
Here, the market and prices are already moving in your favour, and the risk of loss is greatly reduced when you decide to let a profitable trade run for an extended period. You are just extending your profit target as you are quite sure about the price reaching better levels, which results in higher profit potential. So, adjust your take profit levels instead of closing the trade with the profit already realised.
Now, one thing that you need to decide here is what should be your extended profit target as placing an unrealistic profit target can still be risky as the trend might reverse before reaching the set price levels. So, you need to analyse the market in detail and extend the targets to a level based on probability. You also need to decide the best time for exiting the trade.
When it comes to long-term trends, you can let the trade run freely and wait for it to reach your extended profit targets. But keep in mind to have a tight risk management plan as a safety net by placing an optimal stop loss and trading with the set risk/reward ratio. If you follow these tips, target extension can be the best method for increasing your profitability without any excess risk.
To summarise, taking excess risk is a major mistake leading to huge losses, and you can avoid such a situation by following three simple steps. The first is determining optimal risk per trade, 2nd one is limiting maximum exposure to risk, and the final is trading with target extension. So, make sure you follow these steps while trading.