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Forex Risk Management

Before any trader embarks on a trade, there are three questions that he must bear in mind.

1. What is the extent of the market movement and when is the correct time for profit taking? A trader can utilize “Limit Orders” to close his market position when he reaches his profit target.

Thus, if you hold a “Short” market position, you can place a limit order just under the current market price as this is your profitability zone. On the other hand, if you are holding a “Long” market position, you should utilize a limit order above the market price. With the use of limit orders, a trader is able to adopt a more disciplined and systematic trading stance. He can still benefit from the price movements even if he is not monitoring the market constantly.

2. What is the extent of losses that a trader is willing to undertake before closing his market position? With a Stop/Loss order, traders can specify a closing point for a losing market position. If you stake a short market position for a currency pair, then you should place a stop/loss order at a price higher than the current market price. Conversely, if you had taken out a long market position, then the stop/loss order should be placed lower than the current market price.

3. Where to place the Stop and Limit Orders? As a norm, stop orders should be placed nearer to the opening price as opposed to limit orders. If this philosophy is strictly adhered to, a trader only needs to be correct roughly half the time for him to remain profitable. As an example, with a 30 pip Stop/Loss order and a 100 pip Limit order, a trader only needs to be correct 30 % of the time in order to make a profit. Precisely at which point to place these orders will actually depend on how much risk a trader is willing to take. Furthermore, the stop order should not be too close so as not to render it obsolete by normal market fluctuations. With regards to limit orders, they should be placed at the point of realistic profit expectation taking into consideration the duration of the market position and market sentiments.

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