Top Risk Management Principles FX Traders Should Know

Risk management principles for FX

Managing risk when trading FX is one of the key requirements to achieve consistency and not get bumped out by an unexpected market move. Thinking in probabilities is part of the process, which is why this endeavor does not resemble any other regular job. 

The markets are now dealing with a high level of uncertainty, especially as the Jackson Hole symposium is approaching and FED could hint at tapering. That could have major implications for FX market volatility and it would be critical for traders to understand from now on several risk management principles. 

1. There are no risk-free trades

Regardless of trading strategy, any trader should know there are no risk-free trades. The market won’t behave as expected all the time, which brings risk management into the spotlight. A trader’s job is to actively deal with the uncertainty and allocate capital accordingly.  That will require mental toughness, confidence, and preparation, all skills that can be developed in the long run. 

2. Stop loss and take profit are valuable tools

To deal with the uncertainty, FX traders can use tools like stop loss or take profit. Integrated into any platform or forex app, these can ensure the downside is capped when traders are not able to monitor prices constantly. At the same time, a sudden burst of volatility can drive prices in an unexpected direction, leaving traders helpless and vulnerable in the face of high losses. 

A good rule of thumb is to always place at least a stop loss to all trades, ideally before the order is open. Take profit might be optimal if traders have achieved mental discipline and are not psychologically influenced by any minor price moves. However, to lock in a higher return, placing take profits around key support/resistance areas might be suited. 

3. Multiple variables need to be accounted when developing a risk management model

Risk management is not limited to stop loss and take profit. Asset diversification is also important. A beginner should choose a limited number of FX currency pairs and trade only on those until consistency is achieved. Later on, the asset list can be gradually expanded. 

At the same time, other metrics like trading accuracy or risk/reward ratio are used by professional traders to gain more insights into the efficiency of their risk management regime. To achieve a stable equity curve, all FX traders should consider that. 

4. Changing market dynamics might demand tweaks in risk management

Same as the FX market, risk management should not be fixed but very flexible. Depending on how valuations evolve, a different approach might be required to preserve the same performance. Requiring the market developments and also trading activity on a weekly/monthly basis is important to spot these required changes from an early stage. 

The bottom line is that although risk management does not bring certainty, FX traders can fare better with elevated uncertainty. Losses are part of the process, but with proper risk management, losing periods can be offset by winning ones.

The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.