BizHobby

Read any book, visit any forum, talk to any person dealing with Forex and it is inevitable that you will hear about how important risk management is. Here you will find an easy to digest material to help you understand the fundamentals…

Before we can talk about how to manage risk in Forex, we need to undestand why is it so important.

Even with a strategy that wins half of the time (50% win rate) you can experience a sequence of losing trades. If you don’t believe that take a look at the roulette tables in Las Vegas and if you stick around long enough you will see things like 8 or even 10 red numbers in a row.

How is that a problem?

Well if you risk too much from your account it will be hard to get even and potentially get busted pretty quick.

Just get this - if you lose 50% of your account you will now need to gain 100% to get even!!!

Here is a table that illustrates how many losses you can withstand based on how much you risk per trade:

As you can see risking 10% will get you busted on the 7th trade. Mind you risking 10% you will probably be very emotional by the 3rd loss. The rest will follow very quickly. Unless of course…. you get lucky. Which will save you… for now.

So I would recommend stick within 1%-3%. And of course modify it based on your strategy results. But I would definitely recommend scaling down the risk as soon as you get close to a 10% draw down. A draw down of 50% is devastating. With good money management a draw down of 20% should be rare and quickly recovered.

Of course there are exceptions to the rules. If you are working full time and this is your experimental fund. And you budgeted $500/month for it. Then yes… you will have $500 in your account but effectively you have $6,000 you are planning on working with this year. With $500 you can afford to risk 10% and have the ability to execute 3 or 4 opportunistic trades per month. If you get busted and you feel like playing - just use your practice account until the next month! That is what it’s for. Keep in mind though you still need to look at that $6,000 as your “budget” for the year. So it would be wise to never risk more than 2% of it per trade.

To be continued…

Stay tuned for the next part where we analyze how to identify good risk/reward situations!