Controlling the risk of your Forex trading positions

Controlling risk is one of the most important factors of successful trading. While it is emotionally more appealing to focus on the upside of trading, every trader should know precisely how much he is willing to lose on each trade before cutting losses or ceasing trading and re-evaluating his strategy.

Trading financial instruments implies risks and depending on the instrument there could be also instrument-specific risks, that should be monitored or managed. Risk will essentially be controlled in three ways: 1) by exiting losing trades before losses exceed the pre-determined maximum tolerance (or "cutting losses"), 2) by limiting the "leverage" or position size you trade for a given account size, and 3) by keeping a good diversification of the structure of the investment portfolio.

1. Cutting Losses
Almost all successful trading strategies include a disciplined procedure for cutting losses. When a trader is down on a positions, many emotions often come into play, making it difficult to cut losses at the right level. The best practice is to decide where losses will be cut before a trade is even initiated. This will assure the trader of the maximum amount he can expect to lose on the trade.

The other key element of risk control is overall account risk. In other words, a trader should know before he begins his trading endeavor how much of his account he is willing to lose before ceasing trading and re-evaluating his strategy. If you open an account with $10,000, are you willing to lose all $10,000? $5,000? As with risk control on individual trades, the most important discipline is to decide on a level and stick with it.

2. Determining Position Size
Before beginning any trading program, an assessment should be made of the maximum account loss that is likely to occur over time, per position . For example, assume you have determined that your worse case loss on any trade is 30 pips. That translates into approximately $300 per $100,000 position size.

Further assume that the $100,000 position size is equal to one lot or contract. Five consecutive losing trades would result in a loss of $1,500 (5 x $300); a difficult period but not to be unexpected over the long run. For a $10,000 account trading one lot/contract, this translates into a 15% loss. Therefore, even though it may be possible to trade 5 lots/contracts or more with a $10,000 account, this analysis suggests that the resulting "drawdown" would be too great (75% or more of the account value would be wiped out).

3. Diversification
In order to reduce overall risk of an investment portfolio the diversification of the assets shall be improved. There are three strategies to reach this target: 1) spreading the portfolio among multiple investment vehicles, 2) varying the risk of securites by diversifying into different investment strategies, 3) varying securities by industry and/or geography.

special contribution of: Fibosignals.com

Trading on margin or leverage trading

Trading on the Forex market occurs with margin ie. geared or leveraged transactions. Leverage trading, or trading on margin, means that a trader is not required to put up the full current value of the position he wants to open. But there are some important distinctions between trading stocks on margin and trading Forex on margin.

When stocks trade on margin, the leverage ratios are in the range of 2:1 or 4:1 – meaning a trader would only have to deposit $10,000 to the trader’s account in order to trade stocks worth $20,000 or $40,000 respectively. However, this kind of leverage requires the stock trader to be approved for “credit” for the amount invested that is in excess of what is deposited. Moreover, if the value of the stocks falls to a certain level, a stock trader trading on margin may have to pay additional funds than originally deposited to cover the losses.

Forex trading offers more leverage than stocks or futures - up to 200 or 400 times the value of the deposited funds in the Forex trading account. Therefore, at 400:1 leverage, a trader need only put up $25 to trade $10,000 worth of a currency. However, unlike trading in stocks, Forex traders do not need credit approval to trade on margin. If the value of the Forex positions falls to a certain level, your broker will close out (ie. liquidate) all positions so that the trader will never lose more money than initially deposited in the currency trading account.

Keep in mind: that increased leverage increases both a trader's opportunity and risk. For example, at 400:1 leverage, a change of 1% in the underlying value of the trade will result in a gain or loss of 400% on the underlying deposit. So you have to setup a well defined strategy to take profits and cut losses before entering a transaction.

Regards,

A. Black

Foreing Exchange Market and Forex-Quotes

Foreign Exchange: it is also known as FX or Forex. It is the buying and selling of currencies. Unlike stocks or futures, there is no centralized exchange for Forex. All transactions happen via phone or electronic network. Because of this, Forex is among the most liquid of trading instruments. In fact, the daily trading volume of currencies is $ 3.2 Trillion – which is more than all other world market exchange trading combined!

More than 85% of Forex trading volume occurs in the “Major” currencies: US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar.

Reading a foreign exchange quote is simple if you remember two things:

1. The first currency listed is the base currency
2. The value of the base currency is always 1

A currency pair quote is comprised of a bid/ask price expressed in the following format:

EUR/USD: 1.3036 / 1.3038 or EUR/USD: 1.3036/38

The first number in the series represents the bid price, the cost of selling the Euro against the Dollar, or going ‘short' on the Euro. The second number represents the ask price, the cost of buying the Euro against the dollar, or going ‘long’ on the Euro.

The difference between the ask price and the bid price is called the pip spread.

A pip (or “percentage in point”) is the smallest unit of measure for any currency. In most currencies, this is the fourth digit after the decimal point and is equal to 1/100th of 1% or .0001 (or .01 for Japanese Yen as the only exception among the major currencies). So, using the example above (EUR/USD: 1.3036 1.3038), the spread is 2 pips (38 – 36).

AB