Risk Management, a crucial topic in Forex.
Are you losing pips on a regular basis? If so, it’s time to take a step back and review your risk management strategy! Our Risk Management Checklist for Forex traders will help to put you on track.
Risk management is the practice of protecting your trading capital. Mitigating their exposure to market moves is something professional traders are good at.
Below are 10 questions on my Risk Management Checklist for Forex traders that you should ask yourself before placing a trade. This is actionable advice that will help you limit your Forex trading losses.
1 - Am I Actually Ready To Trade?
You might think this is an obvious question, but I’ve seen many new traders let enthusiasm get the better of them. It results in traders placing trades in the hope of making quick profits. While an eagerness to succeed is admirable, it often results in heavy losses.
My recommendation is simple. You need at least three months of profitable trading experience on a demo account before trading with real money. If you don’t have this, you’re not ready to trade.
2 - Do I Understand Risk Management?
If you’re ready to trade, you need to recognize the importance of risk management. Your job is to build your trading capital while doing everything you can to protect it. Reading proven advice such as this Risk Management Checklist for Forex traders is a sign of professionalism and dedication.
Small and consistent profits should be the aim of your trading. If you are intending to trade very big positions, you might get lucky a few times. But the market will move against you – and potentially wipe out most of your capital. Therefore, before you place your next trade, ensure risk management is part of your trading strategy.
3 - Is My Mindset Correct?
Before committing to a trade, check how you’re feeling. If you’re in a state of emotional distress, for instance, stay out of the market.
Traders often neglect both their physical and mental well-being. Needless to say, these are both needed to do anything well. Remember to take care of yourself with a good diet and regular exercise. Trust me, it can make a significant difference to your trading performance. Any decent Risk Management Checklist for Forex traders should include this advice.
4 - Am I Trading With Funds I Can Afford To Lose?
This is critical. You need to assess whether the money you have put aside for your trade is an amount you can afford to lose. Trading money that you need to live is a guaranteed path to failure (and stress!).
If you don’t have money to trade at the moment, commit to building a trading pot which you can add to every month. Practice your trading strategy in the meantime by opening a demo account.
How much money is enough to trade Forex? There isn’t a set answer for this. You’ll be able to find a broker to suit most amounts. But if you’re starting out, my recommendation would be around $1000.
5 - Do I Have A Conflicting Open Position?
As you should know, traders select a currency pair when placing a trade. With this in mind, it’s important to check that you don’t have reciprocal positions open. If you do, those trades will cancel each out. An example of doing this is going long on EUR/USD and USD/CHF over the same period.
6 - Have I Checked Currency Pair Correlation?
In a Forex trade, you’re betting that the value of one currency will appreciate/depreciate against the value of another. That’s why it’s vital to check something called “correlation”. A correlation can either be positive or negative. It reflects the nature of the relationship between two currencies (from -1 to +1).
Let’s take the EUR and CHF as an example. These currencies are positively correlated. In other words, when the price of EUR increases, CHF tends to do the same. This happens because of the economic proximity between the EU and Switzerland.
Beyond this, currency pairs are also correlated. For example, GBP/USD and EUR/USD are positively correlated, therefore when one pair rallies, the other tends to follow. At the time of writing, the correlation between these pairs is 75.4% (or +0.754) for the past month. In other words, the pairs have moved in the same price direction over 75% of the time across the last 30 days.
With the above in mind, you should be able to see that taking opposite positions on positively correlated pairs could result in losing unnecessary pips.
The opposite is true for negatively correlated pairs. Taking the same position on pairs that are negatively correlated could result in losing unnecessary pips.
It’s important to remember that correlation is not fixed. For this reason, you need to check the correlation between your open positions.
7 - Have I Setup A Stop Loss & Take Profit Level?
Traders have a series of tools available to them to protect their account capital. The most common of these is a “Stop Loss”. This an “acceptable loss threshold” set by traders within their trading platform as it instructs brokers to automatically close a trade should its losses hit that set threshold. They are a fantastic way of mitigating risk and warrant an important role in my Risk Management Checklist for Forex traders.
Where to place a Stop Loss is one of the most popular questions I receive from traders. But there’s not one answer to this, as Stop Loss placement depends on the nature of the trade.
Long-term trades need room to breathe, therefore placing a Stop Loss close to your entry level isn’t recommended.
For intra-day trades, a tighter Stop Loss might be necessary. Doing this will protect your capital should the market move against you in a short time frame.
I also recommend that you set a Take Profit level to ensure you don’t lose any profits. I explain how I do this in the video below:
8 - Have I Used The Appropriate Amount Of Leverage?
Leverage is something very common we all use as Forex Traders; think of it as a means to amplify your profits (or losses).
Let’s look at an example. Most brokers offer leverage of 100:1. Using this ratio, traders can choose to place a £10,000 trade with only £100 capital.
Using the level of leverage above means that traders can increase their profits by a factor of 100. But this also applies to potential losses.
The bottom line is that leverage increases the risk of losing capital. I’ve seen many instances where it has led to traders losing their entire account capital.
My recommendation here is simple; If you’re new to trading, don’t use leverage for the first three months of live trading. From there, use leverage lightly and with extreme caution.
9 - Am I Committed To Letting This Trade Go?
Are you willing to accept a loss from this trade? If not, you’re not ready to trade.
One thing that always leads to further losses is chasing old trades. Therefore, as a Forex trader, you need to accept that you will experience losses on occasion.
If a trade hits your Stop Loss, just accept it and try to determine if anything in your analysis was incorrect and move on.