Forex Beginner Learning: How to Maximize Risk Control in the Forex Market

Risk control is the first lesson that every investor who enters the market must learn.

The goal of newbies entering the market is to make money. Everyone wants to make money by investing, and everyone thinks they can make money by investing, but is it really that easy to make money by investing in the market?

Take the Forex market as an example. A 100-point fluctuation in one night can make a profit of 20% or more, but at the same time, it may also lose 20% or more; some people took advantage of Brexit and shorted the pound to increase 10 times in a day, but there were also many people who were liquidated because they were long the pound. There is a saying that goes well, you can’t just watch the thief eat meat, but not watch the thief get beaten!

In the market, no matter how much you earn 100%, as long as you lose 100%, everything will be in vain!

Risk control may reduce your profits, but it ensures your survival, allowing you to live longer in the market and encounter more opportunities.

Risk control is divided into position control and stop loss control.

Position control

Overweight positions are a common problem for novices. The most fundamental reason is that the principal is too small.

The principal is US$1, 000 and the annualized return is 50%. The operating level is the same as the principal is US$10, 000 and the annualized return is 50%. But many people think that there is a big difference between the annual profit of 500 US dollars and the annual profit of 5, 000 US dollars. They tend to value actual profits rather than yields.

Ignoring the difference in principal, blindly pursuing profits, without a reasonable target value, and turning a blind eye to risks will easily lead to heavy positions.

List the data. There are about 250 trading days per year. For investors who want to achieve an annualized return of 50%, they only need to make a profit of 0.2% every day. A principal of US$1, 000 will only make a profit of US$2 per day; a principal of US$10, 000 will only make a profit of US$20 per day. For many investors, a goal of $2 or $20 a day is too small, and they feel that they should not only make such a small amount of money.

So they will never reach 50% annualized return. Or if you achieve it this month, you will lose it again next month. They enjoy the feeling of heartbeat when trading heavy positions, and are addicted to the pleasure of sudden rise and fall, unable to extricate themselves.

Traders who usually hold small positions, occasionally increase their positions when the market is particularly good, and strictly follow the trading plan, sometimes make a lot of profits, but there are also situations where the heavy positions fail and the account shrinks significantly; traders who hold heavy positions for a long time either make deposits - liquidate - deposit - make huge profits - liquidate - deposit in an infinite cycle, or stay away from the market completely.

The Forex market can be operated with 100 times, 500 times or even 2000 times leverage. The average daily fluctuation of currency pairs is about 0.5%. Using 100 times leverage, the position will double or liquidate in two days. When the Swiss National Bank announced that it would abandon the fixed exchange rate between the Swiss franc and the euro, the Swiss franc rose by 30% in one day; on the day of the British referendum to leave the European Union, the pound fell by 12%. How many individual traders can withstand such large fluctuations under high leverage?

When trading is not going well, there may be losses for several days in a row, weeks or even months in a row. If you do not carry out strict position control, during this period, if you lose too much, it will be difficult to earn back your principal.

For novices, the amount of principal is not the most important thing. The key is to study the market, form your own trading system, trade with controllable risks, focus on profitability and ignore profits. When the profitability of small funds stabilizes, it is the right choice to expand the principal and positions to obtain greater profits.

Stop loss control

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Trading is a process of constant trial and error. Light positions give you more opportunities for trial and error, and stop loss can prove whether you are really wrong (or right).

Traders who do not set a stop loss are mainly divided into three categories:

① There is no stop loss level at all;

②Reluctant to stop losses;

③Real-time tracking.

Traders who have no stop loss level at all not only have no stop loss level in their orders, but also in their hearts. When I entered the market, I only saw profits. I didn’t think that the order would be a loss, and I didn’t think about what to do if there was a loss. Ignoring the risks of the market makes them most likely to cause huge losses or deep losses, and then be quickly eliminated.

Traders who are reluctant to stop losses are actually not afraid that the transaction will be stopped, but that the price will come back after the stop loss. The frustration caused by this situation will seriously affect your determination to implement trading discipline. So when the price reaches the stop loss level in their hearts, they always want to wait and confirm again, which ultimately results in greater losses.

Many traders who monitor the market in real time do intraday trading. They have a stop loss in mind, either a specific price, or relying on market feeling, but they just don't set it in the order. Their biggest risk is that prices fluctuate violently in a short period of time, which affects their judgment and even delays transactions, causing greater losses. There are also some medium and long-term traders who do not set stop losses. Prices suddenly fluctuate while sleeping, and when they wake up they find that they have made huge losses.

Since there are so many dangers in not setting a stop loss, how can we set a stop loss correctly?

Stop loss is divided into passive stop loss and active stop loss.

Passive stop loss

Passive stop loss can prove whether you are really wrong. Meaning, when the passive stop loss is hit, you should immediately enter the market in the opposite direction.

Some people may not understand this sentence. Let me give you an example.

You are short the euro at 1.1000, with a stop loss of 1.1100. An effective stop loss should be when the price breaks through 1.1100, the short trend ends completely and the bull trend begins. At this time, you immediately go long the euro and gain the maximum profit. If you find that when the stop loss level is breached, the trend prevents you from entering the market, or the trend does not end, it means that your stop loss is not an effective stop loss.

In actual trading, many stop losses are set based on trend lines or support and resistance levels. This is also a good way to judge whether the trend ends or begins. However, it should be noted that the stop loss should have a certain degree of fault tolerance. If it is 20 points away from the support and resistance level, be careful not to be hit by mistake.

Passive stop loss can filter out the shocks in the trending market and obtain maximum profits; but if the market reverses too slowly, it will cause some losses.

Active stop loss

Active stop loss can prove whether you are really right. This means that when the trend does not go as you expect, take the initiative to leave the market.

For example, if the euro breaks through the 1.1000-1.1100 shock range upwards, you enter the market with a long order. When the price falls back to the 1.1000-1.1100 range, take the initiative to stop the loss and exit.

For another example, you think the data at 9 o'clock tonight will cause the EUR/USD to fall sharply. But when the data comes out and the price rises sharply or only falls slightly, take the initiative to exit.

Active stop loss is often not set in the order, but is monitored and controlled by the trader in real time. This stop loss method has higher requirements for traders, not only accurate and timely judgment, but also strict self-control, otherwise it is easy to be reluctant to stop loss.

Active stop loss can reduce losses, exit transactions faster, re-study the trend and find entry opportunities; but when the market is just retracing or adjusting, exiting too quickly will affect profits.

Practical application

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Finally, I would like to share with you how I control risks.

In terms of position control, the maximum loss per order shall not exceed 3% of the total funds. Before entering the market, find the passive stop loss position, which is the market reversal position. Assuming that the principal is US$10, 000 and the passive stop loss position is 150 points away from the current price, the position should be 0.2 lots; if the passive stop loss position is 100 points away from the current price, the position should be 0.3 lots.

That is, position = maximum loss/stop loss/10. (Divided by 10 because for 1 lot, 1 pip = 10 US dollars)

If you are more cautious, you can adjust the maximum loss of 3% per order to 2% or 1%; if you are more aggressive, you can also take a 5% risk in exchange for profits. 3% is just my reference standard and may vary from person to person.

In terms of stop loss control, I combine active and passive stop loss methods. When the price does not move as expected, half of the position is actively closed; when the price triggers the passive stop loss, the original trend ends, a new trend begins, and you enter the market in the opposite direction. Because my passive stop loss is set according to the maximum loss of 3%, when using the active stop loss, if the direction judgment is wrong, the actual loss of each order will be about 2%, which is lower than 3%, which reduces the risk.

If you are unwilling to miss out on profits and are willing to take some risks in exchange for maximum returns, you can use all passive stop losses; if you want to escape the risk as soon as possible and be safe, you can also use all active stop losses.

My operating methods are for reference only. You can make appropriate adjustments according to your own personality and risk tolerance.