As a commentary to my former article about the forex trading, one of the readers wrote a valuable opion about the risks in forex trading. One cannot argue at all about the high risks envolved in Forex. As easy as it seems, you can make incredible amounts of profits in a very short period of time. But again it is not any harder to loose the same amount very fastly.
There is a tool that every trader use to control the damage you can accept in a trade. It is called stop loss order. It is an automated order that the trader enters following a newly opened position. This preset order tells the broker's computer when to get out of the trade. You may usually enter this value as points in percent (pip) or as dollar value.
Now the question that most traders face is, where to put the stop loss. No one wants to place an order too close to the actual trading price and get out of the trade in a small fluctuation. At the other end, we don't want to loose too much money at any trade.
The answer to that question is highly personal in my opinion. It depends on your account size, your appetite for the risk, how crazy you are, etc. But there is also some commonly accepted ways of defining risk levels.
Most of the traders go for a fix percentage of their account as an acceptable loss. So if you have 10.000 $ in your account and you never want to loose more than 5% in a given trade, your maximum loss should be 500$. Now that is the step one.
The biggest mistake of beginner traders is to get this as a fixed position for a lot. So if you are trading one standard lot, this would be approximately 50 pips. This may be a large, or not enough range depending of market conditions. Let's take a look at the chart below.
It is the 1h chart at the time I am writing this article. The market is extremely volitile these days and you can see the pair has moved between 196.800 and 194.400 during the day (which is a 240 pips range). If we decide to get in a trade now, 50 pips stop loss will be hit very easily.
Let's go to 4h chart and see the support levels for a long trade (buy trade).
First support level below the actual position is around 193.300, about 150 pips below. It is likely that the pair may test this value one more time before going higher. So if we get in this trade right now, we should be ready to tolerate this back move until the support is broken.
So our 50 pips is not enough. We still want to keep our percentage fixed. We, then, should reduce the trade size. Instead of 1 standard lot, we should trade with 1/3 lot.
The problem at this point is that not every broker accepts less than 1 lot trades. If you do not have an account to tolerate 150 pips within the percentage you have already defined, you should not enter in the trade. Doesn't matter how good the trade is, how much money you can make, how likely that the pair will move in the direction you want. You don't have enough money to get in that trade.
First rule I have learned in forex trading is to be able to let it go. It happens often that the market is to volatile so that the risk is not acceptable for my account size. Yes these are the times you can make a lot more money than you can usually make. But remember, these are the times that you can loose a lot more money than you usually loose.
I hope it helps to my fellow new traders. Let me know if there is anything you want to see in my future articles.
