The Importance of An Effective Risk Management

When it comes to the elements of your overall forex trading plan that can make or break your forex business, perhaps the most important is your risk management strategy.

Essentially, forex traders need to have a plan for managing their risk - as well as the discipline to keep to that plan - in order to stand the best chances of staying in business over the long term.

The forex market can often prove even a very savvy trader wrong, so you will need an effective way to manage losses, in addition to a suitable method for deciding when to take profits.

Overall, the general idea when trading forex is to maximize your profits by sticking with winning positions, while limiting your losses to acceptable levels by cutting losing positions off quickly.

Keep Risk of Loss at Manageable Levels

Perhaps the most basic form of risk management practiced in the forex market is in placing a stop loss in the market to protect any outstanding trading position from racking up unacceptable losses in your account while you are doing other things.

While moving your stops to worse levels is a highly discouraged and potentially dangerous practice, some traders find benefit in improving their stop level to the trade's breakeven point - or better - when they have a winning trade. This technique is commonly known as trailing stops.

Another important element of risk management is not having too large a trading position for your risk tolerance or too many trades outstanding. The former situation can wipe out an account in case the trade goes against you, while the latter situation can lead to confusion and a lack of appropriate attention to each trading position.

As a result, having the discipline to keep stops in place at all times, along with not having too much money on the line at any given time, will tend to increase the trader's longevity in the sometimes brutal forex market.

Know When to Take a Profit

While managing losses is paramount to a forex trader, another key way to keep trading risk at manageable levels consists of recognizing when a profitable trade has run its course.

When this situation has been determined - perhaps by observing a set of mutually confirming technical indicators that point to a market reversal - an efficient trader needs to close out the position.

In this case, a profit, no matter how small, needs to be taken. Running winners into losing territory or doubling up on losing trades can often spell disaster for any trader's account.

Doing so will allow them to have the space in both their mind and their trading account to take advantage of other potentially more profitable trading opportunities.

Beware Using Too Much Leverage

Add a highly leveraged trading position in an under funded trading account to the already considerable risk involved in trading forex, and the amount of time for the account to be completely consumed by a relatively common market price swing is often greatly reduced.

Overall, margin and leverage can benefit only those who know how to use them wisely, much like many good tools. Make sure that leverage works on your behalf, otherwise losses can accrue much faster than on an unleveraged trading position.