Risk Management in Forex is everything. But it’s also a broad topic. Let’s narrow it down and give you something you can actually use right now.
You may want to watch the video just for the visual aspect of it alone. It may be easier to follow since we’ll be hitting some pretty technical stuff. Or as always, you can continue reading on…
How you manage your risk is likely the #1 factor in money management. This is the part most traders get horribly wrong.
Don’t think it’s all that important? Rather spend most of your time on finding the best trade entries? You’re gonna end up like this.
What Bad Risk Does
Bad Forex risk management can and will put you in a hole you will never recover from.
All that time spent learning and developing strategies gone. Completely.
I’ll take the number I always start with: $50,000 USD
You start out, you take a loss, you double-down on the next couple of trade so you can get it back….next thing you know, you’re down to $40,000.
You now have to make a 25% return, a return better than Warren Buffet’s yearly average, just to get back to where you started!
Can you do that?
No you can’t, because you’re an idiot.
You will keep going, and take it down to half its original value. In this case, $25,000.
At this point, you would have to double your money just to get back to even. Elite-level traders would have to trade for years just to do this. Your dumb ass has no chance.
Take that $25,000 and stuff it in your shirt. Put it in the backseat of your car. Both of those ideas are better and safer than letting you actually trade it.
Most experienced traders I talked to at some point lost their entire trading account.
Do you want to do that? Because you don’t have to if you don’t want. Just saying.
You can do what I’m shocked myself and other who have taken down their accounts to zero did not do.
You can have an actual risk profile in place every time you trade.
Now Don’t Get Me Wrong
You should take risks in Forex. You should take risks in life. And you should do this all of the time.
Fortune favors the bold Absolutely nothing favors the timid. The bold are the ones you see with wealth and happiness.
The timid are the ones that take shots at the bold from behind a computer screen, because it’s their only recourse and continue to have a growing resentment for themselves because they will always wonder what might have been.
And because they’re timid, and often cowards, they will often lash out from this unhappiness and come after us instead of blaming themselves like a non-coward would do.
And according to Tim Ferriss of the 4-Hour Work Week (love this quote by the way), the timid are actually the ones taking on the most risk!
If we define risk as ‘the likelihood of an irreversible negative outcome’, inaction is the greatest risk of all”
— Tim Ferris
Pick a side.
“Seems Reckless To Me”
It can be, or it can not be. Again, the choice is yours. This part is pretty great.
All of the super rich people you know about, at least the ones that weren’t born/inherited/divorced into it, all take way more risks than you do.
The difference? They do whatever they can to minimize that risk first.
Does this seem difficult to you? Daunting even? Well I have good news.
In Forex trading, you can have this level of risk management already built in. Then all you have to do is make sure you follow it.
From plebeian mindset to mogul mindset overnight. Lucky you for finding this blog.
And Tonight’s Winning Numbers Are….
These are your key numbers and simple equations. Write them down, and have them next to you at all times. Having to come back and reference this blog is a pain in the ass, don’t do that to yourself.
We’ll go over how much to risk, where your stop loss should be, and what your pip value should be. These all involve simple math.
I am the anti-hero when it comes to Forex conventional wisdom. Conventional wisdom is what puts people in the 99% of all traders who don’t make it, and it keeps them there.
But when it comes to how much you should risk, percentage-wise, the conventional wisdom crowd got this one right.
That number is….
You need to make it so that 2% of your entire account is the most you can lose at any given time.
On a $50,000 account, that’s $1000.
This number will be called your RISK.
$1000 sounds like a lot to lose in one trade, no?
Maybe, but if you’re going to make it where you want to be, you need to look at things in percentages, not dollar amounts — that’s poor people logic.
And I have a bit of good news for you:
When you lose, it will rarely be the full 2%.
For this, you need the ATR or Average True Range indicator.
It’s only the best Forex indicator ever created.
And you better be on the Daily chart here, like everyone should be. If not, your numbers are going be out of whack.
Anyway, you go to the currency pair you want to trade (on the daily chart, don’t be reckless). Find the ATR for that pair by pulling it up and keeping the default settings at 14.
The number will be listed in the top left corner of the indicator window.
Now multiply this number by 1.5
We will call this your STOPLOSS, since this is how far your stop loss needs to be from where you are buying or selling.
Make sure before you enter a trade that you always put in a stop loss. Thanks to this number, now you will always know where to put it.
Your Pip Value
How much will be riding on every pip? Knowing this, is a major part of controlling your own risk.
Now that you have the two above numbers, this is easy.
RISK ÷ STOPLOSS = Pip Value
So let’s put one together. We’ll use the above examples.
2% of $50,000 USD? $1000 is my RISK
EUR/USD Daily chart in the picture above had the ATR at 71 pips. 71 x 1.5 = 106.5. We will round down to 106 to make it easier. 106 is my STOPLOSS
RISK ÷ STOPLOSS = Pip Value
1000 ÷ 106 = 9.43
9.43 is my Pip Value.
I will adjust my units/lots to make sure I’m trading $9.43 per pip.
And that’s how it’s done.
What This Does For You
Most people fly blind, coming up with whatever risk profile makes sense for them.
And then they deviate from it depending on how their trading is going. Again, with no rhyme or reason.
Anyone who does this, no matter how good they are at making trade entries will go broke at some point. It’s just a matter of time.
This is how important this stuff is people. Now that you have a structure, the chances of this happening to you are slim to none.
It’s a tremendous advantage.
If you keep going 2%, you would have to lose an exorbitant amount of trades in a row, the likes of which most people couldn’t do even if they tried to, do get yourself all the way down to near broke.
Many people aren’t going to see the real results of having a definitive go-to structure like this in place until down the road when they notice their losses aren’t affecting their overall account that badly anymore.
Every true professional trader has something like this in place. now you do too.
You May Adjust This
If you’re a newer trader, stick to what I gave you. Get used to using it, then as you gain experience 6-12 months down the road, if you feel like different numbers make more sense, then adjust them.
The goal, as has always been the case, is to get you and your system to surpass mine one day.
I don’t like your chances, but I will at least give you what you need to maybe one day get there.
That Good News I Was Talking About Earlier
Most of the time, when I lose a trade, price never hits my stop loss.
Why? Because I have an exit indicator as part of my overall algorithm that tells me when a trend is likely over.
You will need to go out and find one yourself, but when you do find a good one, the amount of pips you’ll save over time can end up in the thousands.
It’s worth whatever amount of time you put into finding one and testing them all.
My stop loss is there for me, just in case price violently goes the other way and my indicator cannot react in time. At least I won’t take a loss greater than 2% of my account.
Now BE CAREFUL
Some people didn’t read this far. Sucks for them. They may easily fall into this trap.
You can over-leverage big time here if you’re careless.
A common question I’ve gotten in the past with this structure is “How many trades can I have open at 2% each”
My reply is, “As many as you want, BUT…”
Do not have more than one trade open at 2% risk that involves going long or short the same currency.
For example, if your open trades look like this:
And all at 2% risk?
You have made a horrible mistake.
You have 6% of your account riding on Aussie Dollar weakness. And as we know, anything can happen in this market.
Random news on Australia (or even China) may come out of nowhere and ruin your trades. The Big Banks may decide it’s time to make the Aussie Dollar stronger.
Worst case scenario, and these cases do happen, you can take a 6% hit on your trade at one time. Good luck digging your way out of that.
All because you didn’t heed my warning. So heed it now.
Do This Instead
There will be times where you are getting more than one signal to long or short a particular currency. Here are three ways you can approach it. I’m not a huge fan of the last one and I will explain why.
If you are getting multiple signals to long/short a currency….
1 – Just pick one of them and go with it.
I often just take the first one I see, go 2% on it, and don’t ask questions. Seriously, seems rudimentary, but it’s worked surprisingly well for me.
If you want to take a more precise approach, you can take the other currency in the pair, and measure it against other currencies.
For example, if the choice is between going long the AUD/USD and the AUD/CAD, look at other USD and CAD pairs and see how strong/weak they look against other currencies. This may make your decision more clear.
2 – Go 1% on each
Never a bad idea. This way, you have 2% behind one currency, but now you have a bit of a hedge working for you since you have it against two different currencies.
3 – If you have a signal on one pair, and almost a signal on the other…
So if the AUD/USD is telling you to go long right now, and the AUD/CAD is only a candle away from doing the same — go long the AUD/USD at 1%, then wait and see if the AUD/CAD gives you a long signal tomorrow, and then go 1% on that.
I hope this made sense. If it didn’t, just ignore it.
It’s a clever tactic to use, but it can lead down a slippery slope. The slope of timidity.
I don’t want to give you a license to trade at 1% risk based on the assumption that something else in the same currency may come along someday. Avoid this logic.
You are going to have many times when another trade comes along, but you’re already have 2% invested in it. That’s life. You’re going to have to let that one go.
Proper risk is more important than opportunism in this game. Proper risk is more important than just about anything.
No Money Management = No Money
If I give you a usable structure, and you don’t use it, don’t complain when your results don’t turn out to be what you wanted.
Controlling your risk is everything. Plug this structure in, avoid the pitfalls, and there should be very little reason for your trading not to get a lot better overall.