Proper risk management can be the difference between a 20+ year long-term career, and losing your capital in less than 12 months. Risk management when trading really comes down to the temptations of the field, and its association with the risk of complete loss.
Trading is seen by many as a “get rich quick” endeavor that will allow them to live their dreams with no effort. If only it were that easy…
Of course, trading work requires no physical labor whatsoever, but it is unfortunately psychologically intensive. You need proper impulse control, shrewd decision making, and the ability to sit tight and wait after making your trades…
How Does This Apply to Forex Market?
The lack of impulse and bad risk management actually applies to forex trading more than many other market. You see, forex market brokers (such as Trade12) are famous for allowing high leveraging. Forex markets trade currencies, which move in less than pennies per day. Thus, making money off price currency motions will require you to use borrowed money.
Not only that, but you’ll be leveraging a lot. It is not uncommon to hear of leveraging of over 100 times in forex markets. Some services also offer up to 400 times leveraging! Regardless, there is an important leveraging rule that you need to take into consideration…
The lower your level of experience, the less leverage you should use.
Why Lower Leverage When Starting Out?
Starting out as a trader, you lack experience. This means that you’ll be making more mistakes, which is natural in any field. Of course in trading, you want to minimize mistakes as much as possible, since that costs you your capital.
Thus, making mistakes at the start of trading is akin to your tuition fees to get a little experience at the markets. When you trade at low leverages at the start, you lose less of your capital, which gives you more room for adjusting and learning. It’s like getting a discount for trading experience!
You shouldn’t be ashamed of starting off with low leverages and working your way up. This is something that any trader has done who has survived in the industry long enough. That, or they had to scrap new capital on a constant basis, which is difficult unless you were born with deep pockets…
But, there’s also another aspect of managing risk when forex trading though, or trading in general. We’ll be discussing that below too…
Diversification to Minimize Risk Exposure?
There’s this idea among traders that spreading your money across multiple markets ensures you don’t lose a lot of money. If you hold that idea, you’re in for a rough time.
You see, risk minimization shouldn’t be defined by diversification. Risk comes from making uninformed decisions. If you’re buying shares for the wrong reasons and without practical research and insight, expect money loss. If you do the opposite, you have a higher chance of a successful trade.
Thus, to mitigate risk, know what you’re doing. It’s as simple as that.
This is an insight that has been echoed often by the legendary investor Warren Buffet, and many market players too! Putting a little of your money here, there, and everywhere, doesn’t mean you won’t end up with an overall losing position to your capital!
Of course, we’re not saying you shouldn’t diversify. Do so if you wish, as long as what you buy is based on an informed decision to make profits. If you’re throwing money at different assets to manage risk, then you might as well just keep your capital in the bank…
This idea applies to the forex markets more than anywhere else. You see, you don’t have that many famous currency pairs to trade in the forex market to begin with, especially with good volume. Thus, the nature of the forex markets force you to live by this philosophy!
Why Trade Forex?
An insight about forex trading
Forex trading has gained momentum these days. It has become somewhat like a craze in many people. Apart from those who are experienced at this trade even amateurs can try their luck by involving themselves in this trade and making money.
Forex trading does not need physical holding of stocks. It is easy and simple to trade in forex. But assimilating the required knowledge about the markets is the key for successful trading.
What is Forex Trading?
Forex trading means trading in foreign currencies of various countries against one another, in a decentralized and a global market called the foreign exchange market. The foreign exchange market is also called as currency market, forex market or FX market. The acronym for foreign exchange is forex.
Forex trading involves the aspects of buying, exchanging and selling the foreign currencies at the determined price or the original price. This is the world’s largest market because of its volume.
The major participants in the market are the large international banks while the financial institutions in the world act as anchors in the trade between the buyers and the sellers of forex.
Insights as to how the trade is carried out
- Forex trading is carried out in currency pairs. Forex trade takes place when a currency is bought and another currency is sold simultaneously. For instance, let’s take a forex trade which involves buying Euros and selling US dollars. In this two currencies are traded simultaneously. One currency is sold and another is purchased.
- Forex trading is carried out through a market maker or a broker. You can choose the currency pairs and start your trade by placing your orders with your broker who in turn places the orders in the Interbank Markets. As you end up your trading session, the broker also ends up the trading session in the Interbank Market. The gain or loss you make in the trade is automatically credited to your account at the end of the day. All these actions take only a few seconds.
The major factors that lure the investors in forex trade are as follows:
- The market is open 24 hours, 5 days in a week. This provides a non-stop access to the forex dealers, globally.
- It is a highly liquid market which facilitates trade in most of the currencies.
- There are many standard instruments which control the exposure of the investors to risk.
- It is a highly volatile market which offers great profitable opportunities.
- The margin requirements in this trade are low with a high leverage to yield.
- There are several options available for trading with zero commission.
All these factors contribute to the attraction of investors to the trade. However, forex trade is a very speculative one. Almost 70% -90% of the trade is speculative. The person involved in the trade has no intentions of taking the currency at the end of the day. It is mere speculation that is carried out on the movement of the currency.
Why one has to choose Forex Trading?
Forex trading is preferred by many people these days for many reasons. Here are a few of them:
Unlike in stock trade, person trading forex is not required to pay any brokerage, commission, clearing fees, government fees or exchange fees. The retail brokers get the compensation for their services through “ask/bid spread”.
In forex trading, the market itself controls the pricing of the currencies. Hence, the trading is usually carried out directly without the intervention of the middlemen.
No Restrictions on the Lot Size:
In spot trading, the trader determines the lot size or the position size and in futures market, the exchanges determine the contract or lot size. This allows the trader to participate in the forex trade even with a small investment.
Lower Transaction Cost:
The ask/bid spread rate forms the transaction cost which usually amounts to 0.1% and less under normal trading conditions. In case of large deals also the spread can be low to the extent of 0.07%. The transaction cost also depends on the leverage.
No Time Restriction for Trade:
The forex market operates 24 hours a day, 5 days a week. Unlike the stock market, there are no timing restrictions. Hence, the market responds to the trade at any time of the day.
Market Cannot be Controlled by any One Person or Entity:
The forex market is a vast one with huge number of participants. No one entity or a person can control the market for a longer time period.
The special feature of the forex market is that even a small amount of deposit can control a larger contract value. Leverage enhances the trader’s ability to make decent profits while keeping the risk level at minimum. However, leverage is a double edged sword. Though higher leverage may lead to higher gains, the chances of heavy losses cannot be ruled out too.
The forex market is a highly liquid one. This is very beneficial for a forex trader. When one trader from any part of the globe sells there is certainly another trader from another part of the globe who buys. No trader is ‘stuck’ in the trade at any point of time. Forex traders can also set their online trading platforms in such a way that their position gets closed as soon as their desired profit level is reached or with a stop loss order close the trade when the position goes against your expectations.
Minimum investment required:
Unlike the trade in stock, futures or options, forex trade does not require a huge investment to commence the trade. Even with a minimum investment, one can enter the forex trade. Mini or micro accounts can be opened initially and as the trader learns about the trade and gets experienced, the investment amount can be increased.
Free demo accounts:
Many online forex brokers such as Trade12 provide the facility of demo account for the trader to trade and hone the skills of trading. All this is for free.
Conclusion: All the above benefits of forex trade tend to lure the people to enter the trade and try their luck.