Forex Trading Foundations: Managing Money and Risk

As lead educational strategist for UK broker Admiral Markets, Chris Svorcik has helped thousands of retail traders develop strategies which deliver strong and consistent returns. To mark Admiral Market’s first birthday, Chris explains the importance of clear money and risk management in a trader’s first 12 months.

Profitability within the first year of Forex trading is a realistic and attainable target for novice retail traders. But this outcome is dependant on many different factors. As an education Forex strategist, there is one aspect of trading which many beginners fail to develop: a professional money and risk management strategy.

It sounds daunting, but developing these systems and strategies is much easier than one might think. Those traders who take the time to develop a methodology of protecting their capital are demonstrating one key trait which separates the winners and losers in Forex trading. It’s called ‘professionalism’. Those who treat Forex as their profession always do better than those who dedicate no time to performing the basics competently.

So how does a first-year Forex trader go about developing a money and risk management strategy? The first step is to establish the correct mindset for optimum results.

• Forex trading is a business, not a get-rich-quick scheme

Sometimes people embark on a journey of Forex trading in the hope of making significant money in a short space of time. It’s understandable, as the internet is filled with hundreds of websites from Forex traders who claim to have quadrupled their income by trading the currency markets. But what many people fail to understand is that Forex trading is a skill which takes practice. It can be compared to learning another skill, such as language or musical instrument. To reach a competent level in these areas, people need time to master the fundamentals. It’s exactly the same with Forex trading. When treated as a profession, Forex trading can yield significant profits – but only over time. This leads me to my next point about the importance of mindset when it comes to trading Forex. I always encourage novice retail traders to treat their trading as a business. Establishing this intention from day one is important, as it reminds the trader in question that preparation is everything when it comes to making pips. Believe me when I say that taking short-cuts when preparing money and risk management strategies always leads to negative results. Another way in which traders can set a professional tone when tackling the markets is by evaluating how they use their time. It should always be used as a commodity. Traders who regularly schedule time to learn and master key trading concepts are the ones who experience success. It’s another way in which traders can demonstrate that they are serious about a career in Forex.
Some practical steps when scheduling time include things like creating a consistent daily trading routine to be used on weekdays. The majority of traders I know actually do this to some extent, but what some fail to do is assess how they are protecting their capital and managing risk. Investing time for reflection in this area is of great importance too.

• Identify achievable trading objectives

The first step in developing a money and risk management strategy is to document realistic trading objectives. Not many first-time traders become millionaires in their few first months of trading. Setting goals which are too high or unattainable is sure fire way of creating future disappointment, which may then lead to unnecessary trading risks. Ambitious goals are fantastic, but traders must be able to judge whether they are achievable. Instead, traders should focus on setting a series of smaller goals that still challenge their ability, but that can also build confidence when achieved. Forex trading should be thought of as a long-term career, so setting goals of this nature is a sensible approach that will lead to steady and consistent gains. Those traders who gamble and get lucky with an over-leveraged approach will be punished by the market sooner rather than later. For novice traders, I would recommend setting a target of between 2.5% to 7.5% ROI for the first 12 months. In years two and three, those targets should be steadily increased.

• Establish systems to protect capital

There are a number of systems Forex traders should create to protect their capital. I’ve seen many unprepared traders wipe out their trading accounts by not having those protective systems in place with one or two transactions. Unsurprisingly, this completely destroys their confidence. Needless to say, before any trading can take place, a clear set of rules are needed to protect funds. So how does one protect capital? It’s simply achieved through risk management, which reduces the exposure of losses for an individual in their trades. A system like this means traders can get through losing streaks without wiping out their capital.
The first thing traders should do is set a cap on their trading account. A cap essentially limits the risk traders can take per trade and per day with a maximum percentage. The cap percentages can be anywhere from 0.1% to a maximum of 3% of the capital in a trading account. Employing a protective stop loss is also an important component of a risk and money management strategy. This tool gives traders the ability to determine the maximum loss they are willing to take on a single position for a particular trade.
When a protective stop loss and capital caps are used in this way, the traders in question can rest safe in the knowledge that their capital is adequately protected.