How To Manage Your Risk When Trading Foreign Exchange

Any professional trader will tell you that spotting profitable trade setups is only one part of the trading equation. Managing the trade properly and minimizing risk while maximizing gains is…

Equally as important. Due to the importance of managing trades and setting profit targets, I decided to give you a sneak peak at how I manage my trades in order to achieve consistent profits in the Forex market.

Before I begin, let me state that the topic of managing trades and setting profit targets is a broad subject that can be expounded upon almost indefinitely. While today’s discussion doesn’t cover all of the details in regards to trade management and setting profit targets, it will serve as a general overview of the subject and provide you with valuable insight as to what goes through my mind when managing open trade positions.

STOP LOSS PLACEMENT

Some scalpers and short-term traders don’t place stop losses, because they generally watch every trade from beginning to end and are out of a trade shortly after it is entered. However, most professional traders, myself included, prefer to adopt the set it and forget it trading methodology, this way we are not stuck staring at our charts all day long. Thus, stop losses play an integral role in my trade management.

When trading Foreign exchange, it’s important to always consider risk before reward. I also consider it important to determine stop loss placement before I determine the position size I want to open for a particular trade. The following theory covers my general thoughts on stop loss placement:

• I always want to place my stop losses at a logical place. This means stop losses should be placed at a level that makes sense in the context of the overall structure of the market and at a level that will tell me when a trade signal loses validity.

• I always begin with the premise that I want the market to take out my trade. Although I may sometimes manually exit a trade when I notice market conditions turning against me, my first option is to let my stop losses or profit targets determine the exit of the trade without my interference. I only manually exit a trade if there is convincing price action that is acting against my position. This type of manual exit is purely logic-based, as all trading decisions should be.

As a recap, I use two logical methods for exiting a trade:

1) I let a currency pair hit a predetermined stop loss that I place when entering a trade.

2) I manually exit a trade due to the formation of price action that provides a clear signal against my position.

The goal of every professional trader when determining the placement of a stop loss is to place it at a level that gives a trade a reasonable amount of room to breathe, but not too much room that may lead to a sizable loss. Basically, I want to place my stops at the closest logical level that will invalidate my trade signal, whether it is price action or another technical indicator. So, I never want to place my stops too far away, but I don’t want it to be too close to my entry point either. I want to give the market enough breathing room to bounce off of its natural retracements, but I also want my stop losses to be close enough to exit a trade before too much loss of capital occurs.

Unfortunately, many traders don’t put as much thought into their stop placements as I do, and this usually ends up in either getting stopped out early on a number of trades that would have been profitable or risking too much capital on any given trade. Many traders place tight stops because they want to trade a large position size. However, this results in trading account suicide, because their trades get stopped out before they even get a chance to begin. As you can see, there is a fine line that often needs to be walked when deciding on where to place stop losses, and I always consider stop losses as an integral facet of my trade management strategy.