With this kind of control, you can crash or fly over the clouds. Unfortunately, the thought process of most traders leads them to crash.
No matter how certain you are about a situation, there will always be the possibility that your predictions are wrong.
Many focus too much on” the big winning operation”, risking too much capital per operation. In this way they neglect risk management in the hope of achieving financial freedom in a single Victorious move.
Successful traders know that there are no guarantees in trading. This is a key principle on which we as traders must develop our mentality.
Risk management is essential, but it does not need to be difficult or complicated. There are some ideas that will help you operate safely and with higher levels of confidence.
Don’t put operations without stop loss
Before we go on, we want to go over the stop loss theme. We know that this topic has been discussed repeatedly in the articles, but we do not want to fail to highlight the importance of placing a stop loss along with your opening order.
You can’t manage your risk without a stop loss. When a trader opens a position without stop loss, the account is exposed with 100% risk.
Think about the possibility of a power outage or a computer failure. What if a central bank intervenes at the same time, moving the market 1,000 pips against you? You will suffer enormous and unnecessary losses.
Dynamic Risk Management in forex
One of the risk management models strongly promoted in the forex community is ” the rule of 2%”
Before placing an operation you calculate the size of the position with your stop adjusted to risk 2% of your available capital.
The idea behind this system is to limit losses during drawdown periods, and gradually increase the risk as your account grows.
It works as follows: If you are on a losing streak, your account will be negative, so when you risk 2% of your remaining capital, you will be risking less money than in your initial operation. This way, the more you fall on drawdown, the less you risk per operation.
This is an effective way to slow down the decapitalization you suffer when markets are not responding well to your trading system. Sounds good so far, doesn’t it?
The only problem with this model is that you have to work harder to recover your losses.
If you use a system where you aim to get 3 times what you risk, your earnings won’t be as good as they were before the losing streak.
Let us give you an example:
Let’s say you start with a $ 2,000 account. You lose a couple of operations and you find yourself down $ 400. The account is now at $ 1,600 .
At 2%, you should now risk $ 32 instead of risking the $ 40 if you had the initial value of your balance.
If you use a profit risk ratio of 1:3, your earnings will be $ 96 instead of $ 120, making it a little harder to recover your losses.
Linear forex risk management
The linear model is a very simple and direct approach to risk management.
You choose a fixed amount of money that you feel comfortable risking by operation, and you continue to risk that amount regardless of whether your account is in profit or loss.
In this model you don’t need to work harder to recover from losses. If combined with the 1:3 risk-benefit rule, you can stay ahead even if most of your operations are losing.
If you risk $ 100 per operation, it means you’re aiming to get a $300 return. This means that if you lose 3 operations in a row ($ 300), you only need 1 winner to recover and return to the starting balance.
So, essentially, you just need to win 25% of your operations to stay in breakeven (not win or lose). The higher the benefit risk you point to, the less operations you’ll need to stay positive.
This approach might not serve everyone, especially the most conservative traders. The linear model does not depreciate losses during draw down periods, nor does it benefit from a positive account.