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Risk Management by Peter Marsden

Discussion in 'Forex Articles' started by wcforex, Oct 4, 2007.

  1. wcforex

    wcforex Recruit

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    Risk management is a term often used with FX trading. It is perhaps one of the biggest factors that separates the winning traders from the losers. Experienced traders know they must use extreme discipline at all times when trading if they have any chance of succeeding. The inexperienced trader may find this part of their trading the single most difficult thing to master. With FX trading it is always essential to have the long term picture in mind. One day here or there really has very little impact on the big picture. It is important that the amount risked on each trade reflects this view. For example there is no point risking 1% of your account per trade for 3 months, then risking 20% on one trade because it is a “sure thingâ€￾. This kind of behavior is little more than gambling and that is not we want. We want the long term odds in our favour. It also potentially undoes all the hard work you did for those 3 months.

    Let's say we have a $10,000 account balance and have developed an intraday strategy and would like to risk 1% of our account balance on each trade:

    Now let's say our strategy is telling us to buy GBP/USD and there is major support 20 pips below price and we want to risk 30 pips.

    1% of our account is $100. So we need to select the position size with this in mind.

    If we divide the amount we would be prepared to risk with the number of pips we are prepared to risk, it will tell us the price per pip we wish to trade. Let's do this simple math

    $100 / 33 = $3.33.

    The pip values of one minilot on GBP/USD are one $1 per pip. So our position size would need to be 3.3 minilots. Many brokers do not allow us to trade fractional minilots so we will round it down to $3. So our position size will be 3 minilots for this trade.

    So the worst that can happen on this trade would be an approximately 1% loss. As no trader can win 100% of the time, and will inevitably go through a bad run at some point, it is essential to ensure when this does occur, it is a minor bump along the road and not a complete disaster to your account. Remember, always think of the big picture.

    Let's take a quick look at what would happen if you used too much risk on your trades and hit a bad run. Most strategies do at some point. Say you were trading with 1% risk per trade your account was -10% at the end of the month, you would need around 11% to get back to break even. If however you had exposed yourself to a much higher risk, say 5% per trade and were -50% at the end of the month, you would need to make 100% just to get back to breakeven, this would be disastrous. Compounding can work nicely for you, but it can also work against you.

    It can be very difficult at first for new traders to consistently use good risk management as it's easy to let your emotion dictate your trading. These are some of the emotions and thoughts I experienced at first:
    “Nevermind, This trade lost, I will just trade will double next time to make it backâ€￾
    “I'm carrying a large floating loss, the market will move back in my favourâ€￾
    “I'm bored I don't have a signal but I want to be in the market and I price will continue to move upâ€￾
    “A hedge fund manager on bloomberg expects the pound to appreciate so I will use high leverage and go longâ€￾

    and many more..

    These kind of emotions are very common amongst new traders and they really are an almost certain way to be a losing trader. It with this in mind that it is very important that new traders trade on a demo account for many months prior to trading live. It is true, that the vast majority of new traders lose all their money in a very short time frame and the vast majority of traders end up losing money in the long term, even many of the big institutional traders. With this in mind it is essential that you are fully knowledgeable and prepared for trading and have got over the emotions that come it.


    :)
     
  2. splithand

    splithand Recruit

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    truth

    It has been one of my largest reasons
    for loss is my compulsive behavior thanks for the reminder
     
  3. sweetcarrot

    sweetcarrot Recruit

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    simple as that

    thanks for this great reminder for risk/reward ratio is what keep good trader headup in his carrer:)
     
  4. HANS

    HANS Recruit

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    Thanks, This is really important to be a success trader. No matter how good you are, we are human and we have emotions... The only way to control it is stick to the trade planes, control de risk and Money managment. I think is more than 75% to be success.
     
  5. ndvima

    ndvima Recruit

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    Good write up

    This is a stepping stone to success in Forex for new traders like me.Thank u so much.
     

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