One of the hottest topics for forex traders is risk management. Are you risking too much, too little or the right amount?
As with most questions in the forex industry there is no set answer. Some traders will insist that you should never risk more than 3% a trade, and whilst this may ring true for some strategies it is not the correct answer for all.
Think of trades such as Andy Krieger’s NZDUSD trade that nearly broke the Kiwi, or George Soros’ famous GBP trade – were these legendary trades risking a set 3% portfolio risk? I doubt it. Famous traders such as Michael Marcus would have likely never been able to massively grow their equity if they had stuck to small amounts of risk. As the saying goes – you have to be in it to win it.
So how do you know how much to risk?
If you’re trading an automated system or a strict rule based trading strategy, it’s likely you have enough data about your systems strike rate, draw down periods, winning streaks & profit potential to optimise your risk management strategy. This is simply a data driven process, and should be composed of both backtesting data & live testing data. Tweak the data to see how the P/L would have performed under as many different risk models as possible. Once you’ve done this it can a easy to find the optimal strategy – whichever made the most money!
The risk a small % per trade answer also rings true for those following forex signals. If you are unsure of the trading strategy used it is definitely wise to keep a low amount of risk per trade, as you can’t be certain of the outcome or strategy performance!
What if you’re a discretionary trader?
As a discretionary trader the amount you risk on different trades likely varies. Traders such as Michael Marcus were able to exponentially grow their trading account by risking large amounts on the right trades. Most traders who have successfully risked large amounts of capital believe they have a strong fundamental reason to do so. For example, George Soros believed that the UK leaving the European Exchange Rate Mechanism (fixing several Fx rates in the euro zone) would devalue the GBP.
My advice – work on scaling into positions. This is a tactic that allows you to incrementally increase your position size without considerably increasing your risk. As price moves in the traders favour the trader adds positions, whilst adjusting the previous positions stop loss. This is also called pyramiding, or averaging up (as it increases a buy trade’s average price).
As Phil Salloum, Founder of Opes Trading Group puts it: “Risk management doesnt only come down to how much money you have in your account. Its how much money you can back.”
The golden rule of thumb always remains this – don’t risk more than you’re willing to lose!