Risk Management 101

With the growth in popularity of mechanical trading systems and algorithmic or "black box" trading, there have also been one too many instances of...

For some traders, the idea of having to think about risk management for every single trade can be tedious. This is why some traders opt to incorporate risk management rules in mechanical trading systems, which can automatically calculate stop losses and position sizes.

Another tricky component to risk management is the ability to control exposure with correlated trades. It's not uncommon to see similar technical setups among pairs with the same base or counter currency, so there may be instances when you'd wind up taking correlated trades.

A more complex aspect of risk management is keeping track of several entries across different currency pairs. After all, it can be overwhelming when you are watching various setups with multiple entry points.

As discussed in the previous section, the use of an equity stop and a chart stop can be combined to calculate position sizes for each trade. Many beginner traders make the mistake of setting the position size first before determining the stop loss in pips, which can lead them to neglect price action.

While stop losses can help a trader prevent larger losses on his trading account, common usage mistakes might lead to a worse performance. Here are some of the ones that must be avoided. One of the most common mistakes beginners make in setting stop losses is placing them too tight. Of course the fear of losing is still very much present among beginner traders or those who are just transitioning from demo to live trading, and it's no surprise when some are guilty of putting their stop losses too close to their entry levels.

Using stop losses is a recommended risk management practice, as this will allow you to set a point where you think your trade idea might be invalidated. From there, you can be able to calculate your position size based on how much you're willing to risk on the trade.

As discussed in the previous section, leverage can get tricky and may lead to margin calls when you don't know how to manage it...

One of the biggest advantages to trading in the foreign exchange market is the ability to take advantage of leverage. This enables a trader...

As mentioned in the earlier sections, reward-to-risk, win ratio, and expectancy comprise an important aspect of risk management. Reward-to-risk or return-or-risk refers to the ratio...

Drawdown is defined as a considerable reduction in your account due to a series of losing trades. This can be calculated by getting the...

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