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The Importance of Risk Management in Forex Trading

Hi, welcome to our very first post and we are going to be discussing risk management as it undoubtedly is the single most important part of success of any trading plan.Aaaaaahhhh, but that is so boring! Well .. boring makes money. Trading is not supposed to be exciting, If it is exciting, there’s probably something wrong with your position size, it is a size too large! Risk management can make or break a winning strategy.What needs to be understood about trading, put very simply, is as one highly successful billionaire businessman in Dubai Real Estate sector said, what he said is, that he never makes business decisions based on how much profit he could make but how much loss he could stomach. If a particular project or building fails, how much does he stand to lose? Could he absorb the loss? Just like any other business, trading as a business is about taking calculated risks.Calculated risks that lead to either moderate or great returns that can be compounded year over year to grow trading capital. Remember, as a trader, returns are never in our control. The only control we have is over risk.Hey .. this is all great and stuff but “how do I make money“? How do I generate enough income to afford the things I want?Well, as Warren Buffett put it, “Compounding is the 8th wonder of the world.”Use any compound calculator and input what just 20% a month compounded would be on a meagre capital of just 10,000$ in just 1 year. A whopping 80,000$!That’s an 8X Return over 12months !! How crazy is that?

You can use this calculator site to run your own compound calculations based on your expected return and capital.

Do we need 1:5 or 1:10 R:R ratio trades to achieve this? Do we need to size like crazy to hit a six out the bag by buying 15lots on a 1000$ account? All this requires is a simple repeatable process to generate 2-3% per trade and compound to beat the market! 

Traders don’t fail, only gamblers do.

95% of traders out there are just gamblers gambling their money away, chasing that dopamine rush, running around in circles, repeating the same mistakes over and over again, for years and years. One would think professionals are beyond this but at the end of the day, humans are humans and we are wired in the casino that is life ..

• Always size with what you’re comfortable with.

• Think in terms of what you stand to lose rather than what you stand to gain

• Manage your running drawdown within a comfortable level if you are trading via algorithms.

• Don’t be obsessed with R:R ratio

• Markets are dynamic and not every trade has to be the same.

• Know yourself and you will find what works for you, Remember Kung Fu Panda!

Understand your psychology and your personality and trade in line with that. If as a personality type you cannot lose 7 out of 10times, maybe adjust the R:R ratio and look for strategies with R:R of 1

Why I put winning trades and profitability down to psychology? Because 95% of people fail and lose money. Why is that? Because we are all living the same collective experience. We all are slogging our asses off in jobs we are not satisfied with, we all go back home and watch the same reels on instagram and we all have the same dreams and aspirations. Inherently, these 95% of people are winning traders if they did the opposite of what they did. But they did not do the opposite of what they did because all of us have that inherent greed to get rich overnight. Hey .. 4-5% a month would not get me a Lamborghini countache day after tomorrow!

Understand what you can and cannot do. Can you watch screens all day? Can you actively follow a position? Are you capable of quick decisions while multitasking if you have a full time job? Many people assume they can but having the mental presence and emotional strength to make a decision that could make or lose money is a path to failure. Our human brains are not wired to process such large amounts of data and there is research that shows that more than 1-2 monetary decisions a day is asking too much from our minds. 

Maintain a Trading Journal. How do you expect to improve if you do not have data to train your brain? Do you know what your trading stats are? How consistent are your risk based returns?

1% risk per trade or 5% risk per trade? Fixed risk per each trade or variable risk within a range per trade? Average into positions or just buy or sell once? Reduce the variables, one advice I would give you is, 

“Optimise, but do not overoptimise.” 

Think about correlations between assets and diversification, make sure you are not entering the same trade expressed 2 different ways and expose yourself to more risk than you intend to.

Don’t jump from strategy to strategy. Get consistent data over a number of trades to make informed decisions. Remember we are in this game to generate alpha that is better than what passive investing would yield. What is the point of trading if your risk adjusted returns are not better than 8% a year that you could get by passively investing in an index fund. Why waste all that time and energy and take stress only to lose money ..