PART 2: The importance of the Risk Management
The risk management is probably the major aspect of the forex trading.Poor risk management could made of a profitable trading system a disastrous one, while a proper risk management could transform a poor trading system in a profitable one.
Many people start using default 0.1 standard lot on $200 even $100 accounts. Some experienced traders do this with a clear purpose in mind, but most of the inexperienced traders just don’t realize the level of risk involved. In more than 50% of the cases, such a risk level is equal to account loss, that is, even with a great trading system.
So, how to manage risk wisely? – Generally speaking, if you are looking for long-term success, you should not risk more than 5% from the account balance in a single trade, no more than 10% on a daily basis, and no more than 20% on a weekly basis. If the trading system opens multiple trades, you should consider this carefully and reduce the risk per trade accordingly. It is very useful to perform backtests and check the historical drawdown of the trading strategy you use.
Let’s say that the historical drawdown in a backtest is 500 pips. Double this number, preparing yourself for a 1000 pips drawdown, and calculate the risk level to avoid losing more than 30-40% of your account in such a case. In the best case you will have a system with three or even more years Real-Money Account, verified performance with a track record of thousands of trades. In this case, you can get all the stats you need and and make highly objective risk calculations.
To optimise your risks/rewards, the rule of thumb is to maintain a 5% risk per trade for one-trade-at-a-time systems and a 0.5-1% risk per trade for multiple-trade systems.
Remember – the risk level is a relative concept! A universal, one-size-fits-all risk ratio does not simply exist. While a 5% risk per trade sounds perfectly reasonable to retail traders, this level of risk is considered insane by institutional traders.
So, give careful thought to the level of risk you are prepared to handle, taking into consideration the importance of the capital you manage. If the funds you manage are of significant importance to you and/or other people, you should by all means reduce the risk you take accordingly.
Use the leverage that the broker provides you with cautiously! The leverage is more of an enemy than a friend. High-leverage trading is the number one reason for bankruptcies.