TradingKey - Every time you place an order, it feels like driving a high-speed car without rearview mirrors — the scenery is captivating, but hidden dangers lie in wait.
Even fluctuations in exchange rates by a few decimal points can potentially drain your account balance.
To survive in the long run, learning to “deal with” risk is a necessary course.
What Types of Risks Are There in Forex Trading?
Before learning how to manage risks, let’s first identify the types of risks we need to be aware of.
Liquidity Risk
It’s akin to shopping at a convenience store late at night when the shelves are sparsely stocked; the items you want may be out of stock, and there’s little room for negotiation — this is what you encounter during a “liquidity slump” in the forex market.
While most major currency pairs, such as EUR/USD, are traded 24 hours a day, niche currency pairs like USD/ZAR or trading during off-peak hours (like early morning in Asia) can make the market feel like that quiet convenience store.
If you want to buy or sell quickly, you might have to “sell at a discount” or “purchase at a premium.”
(Source: Freepik)
Leverage Risk
Leverage is the “magic wand” of forex trading, but if mishandled, it can turn into a “dangerous weapon.”
For instance, with 1:100 leverage, having 1,000 in capital allows you to control a position size of 100,000. Earning just 1% would yield $1,000 (doubling your investment), but losing 1% could wipe out your entire capital.
Interest Rate Risk (IRR)
Central bank interest rate decisions resemble throwing stones into a lake; seemingly small actions can create significant waves.
Changes in interest rates not only affect currency fluctuations but also influence your holding costs — for example, going long on high-interest currencies (like the Australian dollar) could earn you daily interest.
On the other hand, shorting currencies with low interest rates (such as the Japanese yen) may lead to daily charges.
Exchange Rate Risk (ERR)
Exchange rate fluctuations represent the core risk in forex trading and are also a source of profit.
Geopolitical tensions and economic factors such as growth conditions, inflation levels, interest rate policies, and trade balances can all significantly impact exchange rates.
(Source: Freepik)
Credit Risk
If you're gambling in a small casino, there's always the possibility that the dealer might abscond with your money — similarly in the forex market.
Reputable platforms are regulated by agencies like FCA and CFTC and ensure funds are held in segregated accounts—much like keeping money in a bank vault—which greatly increases safety.
Operational Risk (OR)
Have you ever accidentally pressed the wrong button while driving?
In forex trading, common operational risks include mistakenly adjusting leverage levels or entering incorrect take-profit/stop-loss points; network delays that hinder position closure are also common issues.
Account Liquidation Risk
Many newcomers enter trading much like gamblers strolling into a casino; they place orders based on gut feelings without proper risk management—leading to greater losses.
For example, if you open an account with 1,000 and ignore stop−loss measures while facing losses of 200 each time—after five such mistakes—you would face account liquidation. Account liquidation isn’t merely “sudden death”; it is an inevitable result of gradually walking towards disaster.
What Are Some Risk Management Techniques?
Establish a Clear Trading Plan
When you drive to an unfamiliar place, you typically check the navigation first, right?
The same principle applies to trading. Before entering a trade, ask yourself: “How much loss can I tolerate? How much do I want to earn?”
For instance, if your capital is 10,000 and you set a maximum loss per trade at 2200), which becomes your stop-loss threshold.
Additionally, when it comes to profits, avoid being greedy; for example, set a target to take profit at 10%.
It’s also important to choose suitable currency pairs. If you're a beginner, steer clear of less popular pairs like USD/TRY and start practicing with major pairs like EUR/USD or GBP/USD.
(Source: Freepik)
Proper Position Management
First is position sizing by percentage, such as the "2% rule". If your account grows from $10,000 to $12,000, calculated at a 2% ratio, the available capital for a single trade is $240.
In the case of EUR/USD, needing approximately 1,000 in margin for 1 standard lot enables a position of 0.24 lots.
During high volatility (e.g., before Non-Farm Payrolls), reduce exposure to 1% ($120 or 0.12 lots) to limit sudden losses.
Alternatively, there’s a simpler fixed lot method where you consistently trade 0.1 lots regardless of how your account balance changes.
Additionally, stay aware of market conditions so that you can adjust your position size as needed.
During calm periods in the market (like before weekends), it might be reasonable to increase your position slightly;
however, in response to major events such as U.S. Federal Reserve interest rate hikes, consider reducing your position and proceeding cautiously.
An Introduction to the Kelly Criterion
The Kelly Criterion is a trading method based on a mathematical formula that experienced traders use to optimize position sizes according to winning probabilities and return rates.
For example, suppose a trader backtests historical trades and finds a win rate of 55%, with an average profit of 150 pips and an average loss of 50 pips (resulting in a win/loss ratio of 3:1).
The Kelly fraction can be calculated as follows:
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This means you can allocate 36.6% of your capital for each trade.
Setting Stop-Loss and Take-Profit Levels
How to Set Stop-Loss?
Don’t rely solely on intuition! Instead, refer to support and resistance levels.
For instance, if you're going long on GBP/USD at 1.3000, set the stop-loss at the previous low of 1.2950; if it breaks below that level, take the loss—this is known as "technical stop-loss."
Alternatively, you can use fixed pip distances; for example, if EUR/USD is volatile, set a stop-loss at 30 pips, while for GBP/USD, set it at 50 pips—this approach is known as "volatility-based stop-loss."
How to Set Take-Profit?
Adopt an “earnings versus losses” mindset; for instance, if you set your stop-loss at losing 200, ensure that your take-profit target is at least 400 (resulting in a risk/reward ratio of 2:1).
You can also utilize moving averages; when going long, consider setting your take-profit above the 50-day moving average so that you exit if it falls below this threshold.
The Psychological Aspect of Risk Management
In addition to employing physical measures discussed earlier, it's essential to pay attention to the trader's emotions as well.
Traders who allow fear or greed to dominate their actions over time often make costly mistakes. Thus, it's essential to cultivate a strong trading mentality!
