Added: 02/13/2006 |
Forex risk management in trading is the stop-loss orderThe most common and important tool of forex risk management in trading is the stop-loss order. A stop-loss order ensures a particular position is automatically liquidated at a predetermined price in order to limit potential losses should the market move against a trader's position. You should decide on a stop-loss level before entering the market and forex risk management recommend you always place a stop-loss order immediately after a new position is taken. Liquidity of the Forex market ensures stop-loss orders can be easily executed.
You must set up strict stop-loss limits for your losing trades, so that you don't lose more than you can handle. If the market starts going in the wrong direction, don't try to think of excuses why you shouldn't close that position and cancel the order. This is the reason you have to place the order and not just have a stop-loss level set in your mind. Even if the market starts going in the right direction 5 minutes later, you have eliminated the risk of it not turning around. Your trading rules are there so that you can trade by them, not to try to go around them - you would only be hurting yourself if you did.
One of the most deadly mistakes a trader may commit, one which can destroy any trading strategy, is when he (after already being down on a position) begins to think of excuses not to close the position - perhaps the market will suddenly turn around and move in a favorable direction? The trader keeps thinking of this, and doesn't have the discipline to close the falling position, waiting until this happens. The market does not do any favors for anyone. Eventually the trader may be forced to close the position with much greater losses.
Losing the amount the trader was willing to lose using the original stop-loss level probably wouldn't hurt his opportunity to make up his losses. Losing 2,3 or 4 times that in 1 trade can completely destroy any strategy. Not only will the trader lose more money than intended, but he will lose morale as it's now much harder to make up the losses. He will also lose confidence in himself and his ability.
In order to avoid this trouble you must follow a simple rule that forex risk management recommended - Always place stop-losses, not just in your mind, but in the trading system or with your broker. A good habit to get into is to place stop-losses as soon as you enter into a new position.
As well as placing stop-loss orders, forex risk management recommend in most cases to enter limit (profit take) orders at the same time using the OCO order function that most trading systems now have. The reason for this is similar to the reason for placing stop orders.
Whereas with losing positions it can be very tempting to overrun losses, with winning positions it can be just as tempting to lock in a profit too early. By placing limits you will eliminate the risk of not being patient enough and taking profit too early. The target level should also be decided along with the choice of point of entry, not after position has been entered. However, you may feel confident in your ability not to profit take too early, and prefer to monitor the market to take advantage of possible breakthroughs in support or resistance levels. In this case placing only a stop-loss order is an option.
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