No business involves zero risk; every business includes risk. It is important to manage the risk while doing business or trading as that can secure profit. In terms of a trading career, knowing different risk management strategies is immensely crucial as this can save the trader’s capital. In some cases, the trader might be fully concentrated on working on strategies to earn money, but on the other hand, he should also work on various types of risk management strategies.
At first, the trader has to define the risk on the monetary side since one cannot manage the unlimited risk. The risk taken should always be under the manageable margin, and if it goes beyond the margin, the trader may lose the capital amount itself rather than gain profit. In addition, rushing to take a trade may not turn in the trader’s favor, as the forex market requires patience, commitment, and time.
There are various types of risk in the forex market, and different risk management strategies can also be used. Some of the major risks that are involved in forex trading are foreign exchange risk, country risk, liquidity risk, leverage risk, credit risk, risk of ruin, and volatility risk. The welcome traders are usually frightened by knowing the risk factors, but there are some time-tested ways by which one can manage the risk effectively. Now, let us look into the types of risk management strategies.
Contents
Types Of Risk Management Strategies In Forex Trading – A Complete Analysis
TYPE #1: Foreign Exchange Risk
Exchange rate risk, i.e., Foreign exchange risk, is caused by exchange rate fluctuations. Depreciation and appreciation in both currencies, base currency, and foreign currency are what determine the exchange rate fluctuations. In addition, three different types of exchange rate risk are transaction risk, translation risk, and economic risk. There are different risk management strategies to prevent the loss, like using money management systems such as the R: R ratio, stop loss and limit order.
TYPE #2: Liquidity Risk
Liquidity risk is that the currency cannot be traded quickly for a particular period. Most traders use stop loss and limit orders to prevent great loss. But, in the case of a liquidity market, these techniques become useless since the very liquid market affects it. This extreme volatility caused by the government’s movements or other factors turns the market into an unfavorable condition. To avoid this, the trader has to do fundamental analysis and technical analysis, trade major forex pairs, and choose major liquidity providers.
TYPE #3: Leverage Risk
Leverage is a double-edged sword, as it can drag people from rags to riches or from riches to rags. Leverage involves a high level of risk as the trade amount is way higher than the amount available in the account. There are different types of risk management strategies to handle leverage effectively. The solution is that the trader has to analyze the terms and conditions, should use effective money management systems, and regularly monitor the margin requirements.
TYPE #4: Risk Of Ruin
The risk of ruin is when the trader gets no chance to get back the money he has lost while trading. In other words, it’s the probability that one may lose a certain amount of money. Knowing different types of risk management strategies can avoid the risk of ruin. To avoid such loss, one can risk only a minimum amount of total capital, and also, they can put stop loss.
TYPE #5: Counterparty Risk
Counterparty risk is the mistake made by the counterparties in a contract by failing to fulfill payment obligations. Another name, default risk, also knows it. It is crucial to evaluate the counterparty risk before agreeing to a contract. One should thoroughly analyze and have a well workout plan to avoid such loss. Most importantly, one should always trade with a legalized and regulated broker.
What Is Risk Management Strategies In Forex Trading?
Forex risk management is having a set of predetermined rules and methods to avoid the potential risk of losing money. An effective risk management strategy should be formed based on experience and market conditions. Moreover, the same type of risk management strategies may not work in all market conditions. So, two to three well riskless strategies are needed to reduce risk while trading. It includes acknowledging the mistakes and learning from them.
How To Reduce Risk Using Strategies In Forex Trading
There are many types of risk management strategies out there. Using an appropriate strategy can help to avoid the risk of losing money and to gain profit. Different traders work on risk management strategies according to their capital, market conditions, leverage amount, and liquidity. However, some common lowly risk strategies are used by most traders. Now let us look into some common strategies.
Strategy #1
One must understand that there is no 100% working strategy, and the strategies should be modified according to the market’s condition. But, most traders use a 1% strategy. The risk amount should be only 1% of the total capital amount and not exceed that. This strategy is useful for beginner traders. But, in the case of experienced traders, they risk more based on market conditions. `
Strategy #2
The second strategy is the most common among the different types of risk management strategies. The trader’s risk-reward ratio should be 1:2, and it has to be followed at all costs to avoid great loss. If the trade goes on the opposite side, the risk percentage should be 1%, and if the trade goes on the positive side, the reward percentage should be 2%. For instance, if the capital amount is Rs 1000, the target price is Rs 1200, and the stop loss is Rs 900. Most traders don’t follow it, and they tend to lose more money.
Strategy #3
The third strategy among different types of risk management strategies is to have a perfect trading plan. The trader should ask questions like why they take that trade, what will be their action if the trade goes against them, and how will they get affected by it. Moreover, forex trading is a mental game, and one has to know how to keep their emotions in control. Most traders are settled with a small profit and don’t wait for gradual profit, but if the loss happens, they wait. This is the most common mistake made by traders.
Strategy #4
Choosing the best forex trading brokerage platform is crucial as most platforms cost a lot of money. The trader should check negative balance protection, stop loss, leverage, and tighter spreads. If the market condition is not good, the trader should not take a trade on that day as the broker’s alone profit. It is wise to avoid multiple trades in bad market conditions. Most importantly, the trader should check whether a regulatory body regulates the brokerage platform.
Strategy #5
Among all other risk management strategies, the most important one is managing emotions. Making mistakes is common, and one must learn from them. To do that, they can back-test the strategies and maintain a forex risk management chart. Recording the daily trade can immensely help the trader to become better. Most importantly, the trader should not be engulfed with greed and revenge- trading.
FAQ Of Types Of Risk Management Strategies
#1. What is the most used forex strategy?
A commonly used forex strategy is a 1:2 ratio. The stop loss would be one percent of the capital amount, and the profit would be 2%.
#2. How do you manage risk in forex trading?
There are different types of risk management strategies in forex trading. One can choose the strategy according to their capital amount and should always back-test the strategies to avoid further mistakes.
What is risk management in forex?
Risk management is having effective predetermined strategies and plans to manage the loss and gain profit. There are different risk management strategies, and the trader has to choose them according to the market conditions.
Conclusion – Types Of Risk Management Strategies
Though there are many risk management strategies, all those strategies may not be suitable for every trader. What is suitable for beginner traders may not suit experienced traders. Overall, the trader should take risks based on their capital amount, and they should effectively manage the loss. Defining risk based on the monetary side is important, and they should do position sizing to calculate the risk amount.
