What is risk management?
If there’s one thing you need to accept before getting into forex it’s that not every trade can be a profitable one. Nobody wins every time, and that’s ok. A good strategy is one that accounts for possible losses but still sees you potentially profiting in the long run. That’s where risk management comes in. But before you can learn to manage risk successfully, you must first be aware of the main factors that contribute to it.
What is risk in forex?
Risk is defined as the possibility that the outcome of a trade will be different from what you expected, and considering we are dealing with leveraged trading, the risk of realizing substantial losses is even greater.
Risk management then is a set of rules to help you deal with this. It forms part of your trading strategy and ensures that, when things don’t go your way, you can minimize some of the losses that might occur.
The main risks when trading
What are the main sources of risk associated with forex trading? Here are a few you should consider.
Market risk
The forex market is one of the most liquid and can be highly volatile. This means you could suffer losses from any trade. Forex prices are influenced by many factors that affect the overall market. This includes global politics, interest rates, inflation, news announcements and even natural disasters. It’s important to be aware of this before entering the market so that you can create your risk management plan.
Leverage risk
Leverage can be helpful when trading forex, but it also introduces additional risks. You may be able to start trading with less money and your profits can be greater, but any losses can also be magnified. If you don’t correctly manage the risks associated with leverage, an unexpected price gap could even see you lose more than the money you put in.
Liquidity risk
In trading, liquidity risk reflects an instrument’s lack of marketability. Not all currency pairs are made equal. Some see high trading volumes, while others are less liquid. It’s important that you understand market liquidity and how it affects what you want to trade. When a currency pair has low liquidity, for example, the spread is usually higher due to the lower trading volumes. This introduces added risks to consider.