Sword Rack

Forex Risk – How To Manage It And Become A Successful Forex Trader

Forex risk is the probability of loss occurring from an adverse movement in fx rates whilst holding a long or short position.

Managing Forex Trading Risk

One of the advantages that draws investors to currency trading is the higher leverage available as compared to the other financial markets. One of the greatest mistakes a newbie fx trader can make is not understanding the effect leverage has on their bottom line. You have to pick the best forex system for risk management.

What is leverage?

In the forex markets, leverage is where a forex trader controls an amount of money with a bit of his own money (margin) and borrowing the remainder from his forex broker.

Example

A trader with an $1,000 margin, can control $100,000 of foreign currency. The leverage, expressed in a ratio is 100:1. Now if we invest this $100,000 in a foreign currency, which then subsquently rises to a value of $100,500, that is an increase of $500.

What’s the return on the investment?

If we had invested at a leverage of 1:1, which would mean we invested $100,000 to manage $100,000 worth of foreign currency, hence the return could be $500, or a miserly 0.5%. But now when we invested with in the same trade with 100:1 leverage, which would mean that for an margin of $1000 we’d control $100,000 of foreign currency. The return in this trade would be $500 on an intial investment of $1000, or a massive 50% return.

Leverage – the double edged sword

That is all good but if the investment / trade went the other way and the investment lost value and returned only $99,500. Well if we were currency trading at a leverage of 1:1, we would lose $500 or 0.5%. That’s no big problem when you start with $100,000. It is a completely different story if you were trading at 100:1 leverage. A $500 loss on an investment of $1000 is minus 50% return on your money and that is a big problem when you started with $1000.

How to use leverage to reduce your forex risk

With the above examples, it’s not hard to see that the most important aspects of managing forex risk is ensuring that you apply suitable leverage to your forex account. The greater the leverage the higher the profits but the downside is the highly leverage accounts likewise have potiential to rack up massive losses. By choosing the correct leverage for your account, this can enable you to place your stop loss orders with sufficient room to cover any spikes in the forex market. Every currency trader will at some time or other have a series of trades go against them. This is the nature of fx trading. But having a run of losing forex trades and too much leverage will result in your account being emptied in a flash. The majority of the forex brokers will have a range of different leverage options. So make sure that you pick the correct leverage for the size of your trading account. To be a successful forex trader it is esstential to have a good forex risk and money management strategy.

Now, if you’d like to invest in foreign exchange accounts, make sure you invest only to whom you can trust. Reliable system, good track record and reputation. If you are a new trader and would like to learn more, you might want your question to get answered. Forex faqs.

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