Most traders find it hard to follow simple risk management rules. Too often, traders turn winning positions into losing positions and find solid strategies result in losses instead of profit.
Regardless of how knowledgeable and intelligent a trader maybe about the markets, their own psychology and emotions will cause them to lose money. What can be the cause? Are the markets so enigmatic that only a few succeed in making profit?
Really the likely cause is that there are common mistakes that many traders commit in their trading. The excellent thing is that the problem while it can be emotionally and psychologically challenging can be grasped and solved.
Most forex traders lose money in the long run. They fail to learn or know and apply proper risk management rules while trading. Risk management means knowing how much you are willing to risk. It also means knowing how much you are looking to make in a trade.
Without a sense of risk management many traders hold onto a losing position for an extremely long amount of time and take profit on a winning position far too prematurely. The net result is that traders end up with more winning positions than losing ones but their account Profit/Loss (P/L) is negative. Keep these simple risk management rules in mind while trading.
Risk-reward ratio is very vital for you to know. As a trader you should calculate a risk-reward ratio for every trade. In other words, you should have an thought of how much you are willing to lose. You should also know how much you expect to gain in a trade. A general rule of thumb is that your risk-reward ratio should not be less than 1:2. Having a solid risk-reward ratio helps eliminate a trade that is not worth the risk.
Use stop loss order to cap the maximum loss that you are willing to accept. Using stop loss helps you avoid the worst case scenario where you have many winning trades but a single loss large enough to wipe out all your profits in the account. Using trailing stops can be excellent thought.
There are two parts to placing the stop loss order. 1) Initially placing the stop loss at a reasonable level and 2) trailing the stop meaning moving it forward towards profitability as the trade progresses.
There are two recommended methods of placing the stop loss order. One method involves placing the stop loss order 10 pips below the two days low of the currency pair price. For example, suppose the EUR/USD pair recent low was 1.1300. The previous day low was 1.1200. Then place the stop loss at 1.1190, 10 pips below the two day low if you want to go long.
Another volatility based method is to use the Parabolic SAR indicator. It displays a small dot at the point on the chart where you should place the stop loss. Parabolic SAR is a volatility based indicator. You can find it on the charting software provided freely by your broker.