Five ways to control and manage risk in the forex market
You must have heard the term 'Day trading' but do you know what it actually means?
Day trading is a practise followed by traders to buy and sell securities and commodities in the market intraday & not hold it. Day traders operate at a very high risk, since their main goal is to make quick gains in short time.
Unlike long term traders who invest in blue chips stocks and mutual funds and reap rewards slowly over years, day traders are all about quick money.
So, as a day trader you stand the chance of losing all your money with one wrong trade if you risk is very high.
This is why you need to understand what are the most common mistakes that Forex Day Traders commit and how you can avoid them.
1.Trading with an unlicensed & unregulated forex broker
You must choose a good & regulated broker which suits your style of trading. The first step to Forex Day Trading is to register yourself with a broker and open your trading account.
Now there are thousands of brokers, which one do you choose from?
All major countries have specific regulators for the drafting policies and governing Forex trading practices. Some of the well-known international regulators are ESMA, BaFin of Germany, FCA of UK, CySEC of Cyprus, Finma of Switzerland, CONSOB of Italy, CNMV of Spain in Europe and ASIC in Australia. Other regulators in markets where online forex trading is regulated include FSCA of South Africa & CMA of Kenya in Africa, MAS of Singapore & Bappebti of Indonesia in SE Asia.
These regulators have a set code of conduct for every broker and trader which is governing in their country. Every broker who wants to offer services to the people of a particular country must get a license from the regulator of the country.
To find out who is the regulator in your country, you can find out through other traders on forex forums like forexfactory.com or find all the information you need on the internet. Cross the check the information multiple credible news sources.
The regulators have certain regulations that all brokers must be follow, it's only after satisfying these conditions, the broker will be given a license. Even after getting a license, the broker will be constantly monitored by the regulator.
The problem with new traders is that they are not aware who is licensed and who is not, so as a result of this many new traders register with unlicensed brokers. Unlicensed or offshore brokers don't come under the jurisdiction of your country's regulator which means that you can't file a complaint against the broker with your country's regulator.
Offshore brokers often target traders who are looking for high leverage or promotion or traders who are not aware of the regulations. In many developing countries like in Nigeria, Malaysia, Thailand & Vietnam; where there are no local regulations related to online forex trading, many offshore brokers operate there and take on clients using offshore regulations through online marketing & localization.
As per Trade Forex Malaysia, around 40+ leading CFD brokers have built their local websites in Vietnamese, Thai & Malay language targeting local customers without local regulation. Many of these websites were also flagged by local regulators like Bappebti in Indonesia and SC of Malaysia.
So, ensure that the broker you choose is licensed by local regulator in your region and follows all the regulations.
2. Not Using a Stop-Loss & Limit Orders
There is a feature called Stop-loss that almost every broker offers. Stop-Loss is one of the most essential risk management features of trading and helps control your losses.
Let's assume that you are trading EUR/USD currency pair in the market. The price of the pair keeps fluctuating ever second but you are unable to constantly monitor the price, so what do you do?
Let's say that the price is 1.2030 and you have a feeling that the price will go up to 1.2070. To reach 1.2070 it can take hours or it can take seconds, it entirely depends on the market and the volatility of the market.
So, if your target price is 1.2070 then use the Take-profit order to set your target price at 1.2070. Now the next things you have to do is determine how much loss you can handle, so you choose a limit. Let's say your limit is 1.2010, you can set a Stop-Loss at this price.
The function of the Stop-Loss is automatically cut off your trade if the price reaches either the target price or has reached the maximum limit for loss you can take.
In the example we used, if you don't set your loss limit at 1.2010 and choose only target price then you could lose so much more than your initial investment if the market goes against your position.
So always ensure you use Stop-Loss to control losses and achieve targets.
3. Adding to a losing position to average down
Have you ever tried to add more money to a losing bet so you can end up earning a lot if all your bets are right?
For example, you are betting on the fact that the EURUSD price will reach 1.4100 so you buy one lot EURUSD trade at 1.4000, but market goes down 50 pips, and you add another mini lot at 1.3950.
Even though the market is going down and down, you are still betting against the market and incurring more losses hoping that you would recover and double your profits. But if the trade goes wrong, you will be liable to pay heavy losses for both orders that has the possibility of sweeping your account clean.
This is not sports gambling where you bet more on a losing team more and more expecting them to win.
4. Not having a Trading plan
Having a plan is the starting point for every investor/trader. You need to set goals and establish your strategy going forward. Especially when money in involved, your plan needs to be as fool proof as possible.
There are so many commodities and instruments available in the market, you will not be able to trade in all. If you try to trade in all then you might as well say goodbye to your money.
An advice which is given by experienced traders to new traders is to have a good idea about what is it that they exactly wish to do and what is their ultimate goal.
If you are going to trade in the currency market, then you need to choose maybe 2 or even 3 pairs that you will monitor continuously and only trade in those currencies.
Have a weekly or monthly target that you wish to achieve, beyond that you need to stop trading.
5. Using Excessive Leverage
Leverage is the most debated aspect of the Forex industry. Prior to leverage capping by regulators, brokers used to offer as high as 1:2000 leverage ratio.
For example, you invest $500 & use 1:100 leverage to buy a currency pair. The 1:100 leverage allows you to trade up to $50,000 using margin money. If the price goes up then you stand to make a profit; but, if the market conditions are unfavourable and the price drops more than expected, then you could be liable to pay more than your invested capital resulting from negative balance; which could be much more than the money you invested.
In turbulent market conditions, like in March-April of 2020 at the start of pandemic, ASIC reported that thousands of forex traders received margin calls & more than 15000 accounts fell into negative balance and traders lost more than $774 million AUD in this period; following which stricter leverage caps of 1:30 were imposed.
But these days negative balance protection is mandatory by regulators which restricts a trader's losses.
Further, most major regulators have ensured that brokers don't offer more than 1:30 leverage to traders due to history of huge losses in the past for traders. If a broker is offering more than 1:30 ratio then most likely than not they are not licensed and you should not trade with them under any scenario.
You should be aware that more than 75% traders lose their money while trading CFDs, so you should not trade CFDs if you don't have the required experience, even experienced traders know that the market is uncertain & profits are not assured.
Make your choices carefully and start your process by educating yourself about the forex market & CFDs.