August 15, 2018

Forex Risk Management Example

Forex Risk Management Example

As mentioned before, risk management is one of the most critical skills in trading. I have provided a forex risk management example below for your consideration. In it, I highlight the essential aspects of placing your stop loss, the risk to reward ratio, and moving your stop loss to decrease the risk to reward.

These are all aspects of becoming a risk manager as opposed to risk taker/profiteer. We all want to make money from the markets but my article highlights the importance of focusing on controlling one's risk as opposed to making profits. The irony again is that the more you focus on making a profit, the less you make, while the more you focus on controlling your risk, the more you tend to profit

Trading as a Risk Manager


The forex risk management example below demonstrates how I stay focused on managing my risk. The very first step in the whole process is always choosing a strong versus weak currency pair based on the fundamentals and shorter term sentiment. This choice in itself makes for a less risky trade because you'll base your trade on what moves the markets.


By focusing on offsetting risk, you will be picky with your trades and mostly only choose the higher probability trades. Before you make the trade, you will not only choose the best set up but one where there is more reward than risk. Once you make the trade, you will continue to monitor the trade for reasonable opportunities to reduce the risk further.


Focusing on reducing risk means you'll also be less prone to FOMO. FOMO is a result of having an improper focus on future profits rather than the present steps to get there. Too much focus on profits rather than the task at hand can place you in an almost euphoric state which always leads to inattentiveness.

Areas to Place Stops

In the following example, I placed the stop just above a swing point and moved it from there. This stop placement provided about a 24 pip stop loss. The target was near the recent support and the position at which the stochastics and the Money Flow Index became oversold. I didn't know precisely where this target was in advance but had an idea that it was higher than 1:1.


Also, the stop was not static. It was moved closer to break even the closer the price got to local support. Support can act a position where other traders may buy back the currency pair thus forcing the price action in the opposite direction. This forex risk management example applies to all instruments, not just forex since all investment devices have areas of support and resistance, oversold and overbought. What differs between instruments is the fundamentals/news related reason for entering and exiting the trade.


The whole point of adjusting your stop is to lower the risk in the trade. Again, this objective should be paramount in your mind at all times. Ask the question: What can I reasonably do to reduce the risk? What you don't want is to minimize the risk unreasonably, that is, in a way that doesn't allow the price action to breathe.

 

Reason for Moving Your Stop

We move the stop to lower the risk involved. If we do this consistently and reasonably, our average risk to reward will be reduced. If we combine this with a flexible exit, one that allows for the highest reward possible on a consistent basis, then we will end up with a low risk to reward on average. We are aiming for a 1:3 risk to reward on average. We also move the stop loss when too much time has elapsed.


The longer the time from entry the less useful the reason for us entering the trade becomes. A longer time also means more opportunity for other news events which could contradict our original purpose and move the price in the opposite direction.


One must also keep abreast of current news to ensure these news events do not hamper the present trade. The degree to which new information may affect a trade must also be considered. New reports may temporarily reverse a trade but not be powerful enough to change the overall trend.

Risk Management Example

The above video is an example of a USDCAD trade that I made based on the Canadian trade balance report and U.S. unemployment report. Both were released at the same time, but the Canadian news was surprisingly positive while the US report was overall negative. This Canadian report had to be taken within the context that the CAD was still weak because of NAFTA concerns. I didn’t expect the USDCAD trade to have much momentum and so I set the target at the nearest low.

A nearby high determined the stop loss, and the exit was more fluid. I based the exit on adjacent support and when the stochastics indicator reached the oversold region. What we have here is a confluence of indicators that help us find a higher probability exit.

forex risk management example


Conclusion

The USDCAD trade is just one example of how to lower the average risk to reward while still allowing the trade to move to target. It is essential that the trade is given time. It is normal to want to move the trade to break even quickly and then take profit at the nearest sign of reversal.

Trades should be given time to move in our favor, and then the stop can be transferred to break even. Also, the trade should be allowed enough time to reach target otherwise the average risk to reward will not remain small. Often we move a stop loss to break even too quickly or take profit to quickly. This tendency is a result of another fear: Fear of Losing Money. We cannot let this fear dictate us as it again leads to a lower risk to reward.

To overcome this fear and FOMO, refer here. This is an article that deals with how to visualize to overcome bad trading habits. Practicing it on a regular leads to real change.

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Understanding Forex Risk Management

Trading is the exchange of goods or services between two or more parties. So if you need … This is a practical, easy to manage, day-to-day example of making a trade, with relatively easy management of risk. In order to lessen the risk, Person  …

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John Leonardo


John Leonardo invests and trades in forex and crypto on a regular basis. He publishes his articles on trading/investing regularly on both the blog and youtube. When trading, John explains how and why these trades were entered so people can learn about implementing the combination of technical, sentiment, fundamental and news trading.

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  • Thanks alot for this article…. I don’t really know much about Risks management  I have seen several articles on this but wasn’t really intriguing but honestly yours is wow… Very informative and well constructed……….. I like your take on risk management in forex.  Your website also looks contemporary. Thank you so much for this.  

    • I really do believe that traders focus too much on making a profit. This focus results in using too much leverage or taking too much risk in one form or another. Whether it’s taking low probability trades or entering late into a trade because of FOMO, a trader increases his odds of losing by not have the discipline to wait.

      This lack of discipline comes from an improper focus. If you focus on making money, you’ll take unnecessary risks, which will accumulate over time. This accumulation of bad trading decisions results in a lack of profitability.

  • Hello John,

    Forex trading is something I look into a few years back, but did not follow through.  I can see the concept of risk management working with any type of trade.  Like you stated most people look ahead to how much money there is to make.

    I want to go with the least amount of risk.  Do you deal in forex predominantly?  Well written site and the example was helpful.  Great images, video and engagement of readers.

  • Hello there.

    I really liked your post, it was really informative and really well written.

    I started with Forex like 2 years ago and never moved away from demo account. I tried trading and lost all my money. After that I was not so confident investing my own money in this project. I loved your take on risk management in Forex. Your website also looks so modern and fresh.

    Can you let me know is anything changed with Forex in these 2 years.

    Thank you.

  • Yes you are quite right to point our quite possibly the most vital point of trading. Risk management. Because without knowing how and where to place your stops, you could lose a fortune. I think you offer some very well considered advice and hopefully people will take heed of what you have to say on this topic. Thanks, kenny

  • This may be the most important article anyone could read when trying to trade Forex.  I tried for many years but in the end had to stop due to lack of finances.  Learning the strategies is the easy part.  But learning to manage your risk, staying disciplined, and following the plan are the hardest part, which is why most fail.

    I particularly liked reading the section on stop losses as this is so crucial when trading.

    Do you teach strategies yourself?

    • Managing risk should be organically combined with trade psychology. The fear and greed aspects are real, and you will give into one or the other unless you work on your trade psychology as well.
      Also, I think too many people depend on technical analysis alone. I believe that simple technical analysis is not enough. It all cases that I’ve seen, technical analysis for the pros has always been combined with volume, statistical or volume analysis for long-term success.

      I did a good amount of research on the following articles on fear and greed, and meditation for trading.

      https://andiamolireforex.com/fear-of-missing-out-and-trading/

      https://andiamolireforex.com/meditation-for-traders/

      I have a course that I have written, but I have to record it. My time is being eaten away by too many other priorities, but I’ll get to it eventually. If you check the quiz out linked below, you can sign up for my newsletter at the end of the quiz. I’ll notify people through the list when the course is available.

      https://andiamolireforex.com/forex-quiz/

  • I don’t know, I’ve been stopped out on option trades in the past. I don’t trade forex, but there have been too many times where a stock will drop below my stop, then rocket too the moon.

    I prefer to calculate my risk when I place my trade, but I am a stock option seller, and I use a delta of .30 when I decide to place a sell to open.

    How can I learn about forex trading for beginners? I feel like I stumbled upon step 10, and I need to be on step 1.

  • Hei,
    Thanks for an informative post on limiting trading losses.
    I have played around a little with binary trading and forex pairs, but haven’t really had the time to do proper analysis so have decided it is safest to keep away for now.
    Are there any good reputable trading systems that can help automate this or is it more something you really need to have your finger on the pulse of ?

    Cheers

    Tony

    • I don’t think that you’ll find an automated system that works well for retail traders like ourselves. You’re going to have to manually trade so that you can remain flexible with changing market conditions.

  • Thank you for the information. Trading is a very important subject. It can sometimes even be very risky, so I’m glad you told us about risk management. That is the most important thing when it comes to trading. We don’t want to get involved in a situation that is going to be way too much risk than what we can handle. Excellent article. Thanks for the insight.

    • I would not risk more than you can afford to lose. His methods work well as long as their traded manually so that you can apply discretion. A superior method incorporates these technicals with the fundamentals.

  • Hi John
    This is such a great article and written with honest information for people and I want to thank you for this. so many sites are full of false information today and it is refreshing to get some really great solid information and I am sure all the people visiting your site will feel the same so thank you again

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