Making thousands of dollars within a few clicks? Yes please!
That is the social appeal of forex trading. The instant gratification and the adrenalin rush can often blur the line between strategically trading the markets and gambling.
To sustain as a profitable forex trader long term, however, is beyond clicking the “trade” button in seeking the jackpot trade to financial freedom. The reality is successful traders maintain the discipline in risk management every single trade they take.
Only trade when the odds are in your favour
As a start, it is important to understand the dynamics of the market being traded. Every asset class has its own patterns and psychological price trigger points. But in general, most traders analyse the market with two common approaches: Technical analysis and fundamental analysis.
Technical analysis
Primarily, technical analysis is chart reading. By relying on past data in the form of indicators and price actions, one can plan a trade with the belief that the buying and selling actions of the market reflect the sentiment tied to a particular financial instrument. Indicators such as chart patterns, support and resistance levels, price trends, moving averages as well as volume and momentum indicators all fall under technical analysis.
Read more about technical analysis.
Fundamental analysis
Another aspect of analysing a market is by looking at the intrinsic value of an underlying asset via related economic and financial factors. These include macroeconomic factors, such as the state of the economy and industry conditions; to microeconomic factors, like the effectiveness of the management of a company.
Fundamental analysis tends to point to the long-term direction of an asset class. However, majority of CFD trading are short term in nature, and as such fundamental analysis tends to receive less attention.
Developing your own trading plan, and sticking to it
A trader can decide based on technical and/or fundamental analysis whether the odds favour opening a trade position in the market. However, a trading strategy must entail the level of risk exposure undertaken, and the trader must psychologically accept the risk level as planned.
Without a proper risk management strategy, opening any position in the financial markets is no different from gambling. This is how most traders have their accounts wiped out and never trade again in their lives.
The 2% rule
A good way to start is by looking at the trading capital of any given account. The common practice among traders is to risk no more than 2% of trading capital per transaction. This is also known as “the 2% rule”.
For example, in a $500 account, the maximum loss should be limited to:
2% x $500 = $10 per trade
The rationale behind this rule is founded in the possibility that a trader can be wrong fifty (50) times in a row before the account is wiped out. This greatly improves the chances of survival for a trader in the long run.
To make the execution of a trading strategy more effective, a trader can use the Stop Loss and Take Profit feature to ensure that the risk level initially planned will be adhered to. By setting a stop loss or take profit order, not only a trader can relax without staring at the screen all the time, but also remove the possibility of making an emotional decision.
Is the risk worth the reward?
The risk to reward ratio marks the potential profit a trader can earn for every dollar risked on a trade. This is used to justify if the risk is worth taking for the reward one can potential. A trade with a risk to reward ratio of 1:7 would mean that that a trader is risking $1 for the chance of earning $7.
Obviously, the higher the reward makes a trade more attractive to take, and this is how traders often plan which trades to take. The more experienced a trader is, the more he knows being selective in opening trade positions would help in surviving the markets.
Leverage: The double-edge sword
Put simply, leverage is the use of money of the broker rather than the strict use of your own, which is very common in the CFD trading industry. A trader could put down a deposit of just $500 to open trade positions up to $250,000 with 500:1 leverage.
What does that mean?
With every $1 profit you make using your own money, you can make up to 500 times of that. However, the reverse also holds true.
With every $1 profit paper loss you are holding, you will also be holding 500 times of that if your position has not been closed yet.
This is why it is important to balance the use of leverage against the 2% rule. While maxing out on leverage can lead you to the Lambo dream, it often wipes trading account out fast.
Staying cool and calm is the trick
Of all the risks, the hardest risk to manage is the emotion of the trader himself. Learning the details of how to plan a trade is nowhere as challenging as executing the trade without emotion. Often, traders stray away when the market move in a certain direction, not taking profits or stopping losses as planned.
All traders must take responsibility for their own decisions, whether this is a result of failure to plan, unexpected event or just because the trader got emotional himself.
While automation can help to negate emotional decision making, the best way to objectify this is to maintain a trading journal, jotting down the details leading to the success or failure of each trade.
Copy how others manage trading risk
If you are unsure how to manage your trading risk, consider using the Copy trading feature for a start. Copy trading is a form of social trading where new traders can replicate the trades from the seasoned traders. By doing so, you can benefit from the expertise of others as you keep learning about the financial markets.
Profits will follow if risk is managed well
Risk management is one of the most overlooked areas in trading. With a disciplined approach and good trading habits, losses can stay under control and any trader will have a chance of being profitable. Explore 1000+ assets being offered by VT Markets and tart your financial trading journey today!
