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Risk management

Trading the financial markets carries a significant risk to your capital – that’s why it’s of the upmost importance you manage your risk while trading. Here we’ll take you through ways of limiting your risk.

 

Risk per trade

Before deciding to place a trade, you should decide how much capital you’re willing to risk. It’s important to know your cut-off point if the markets turn against you.

This cut-off point is based on your risk tolerance – as a trader you must accept the risk associated with trading. If you accept the potential loss, then go ahead and place the trade. If you can’t tolerate the loss, then we suggest not to place the trade, but look at decreasing the risk of your trade.

Some traders are only willing to risk between 1-3% of their capital on any one trade. You might draw a line and say that you’re not going to risk more than 2%. You should decide what your risk tolerance is and stick to it.

Once you know your risk, you can then decide where you’re going to place your stop loss. A stop loss can be insurance for your trade so you don’t lose all your capital. It’s important to note that stop losses aren’t completely fool proof – if the market gaps, your trade may not get closed out at the desired price. Market gapping is when there’s a sudden movement in the market over a very short period of time.

 

Examples

If you have $10,000 in your account and you’re willing to risk 2%, you’ll need to work out your position size for the trade. You should take into account the currency pair you’re trading, for example, $200 risk on the AUD/USD is not the same for the NZD/CAD – the ‘per pip’ risk is different for each currency pair.

 

Trading 1 lot of AUD/USD with an account denominated in AUD

Lot size = 100,000
One pip = 0.0001
Exchange rate (AUD/USD) = 0.7465
Per pip = 0.0001 /0.7465 * 100,000 = $13.39 AUD per pip

 

Trading 1 lot of NZD/CAD with an account denominated in AUD

Lot size = 100,000
One pip = 0.0001
Exchange rate (AUD/CAD) = 0.9907
Per pip = 0.0001 /0.9907 * 100,000 = $10.09 AUD per pip

As you can see, trading different currencies means that your pip sizes will be different – trading AUD/USD has a risk per pip of $13.39, while trading NZD/CAD has a risk per pip of $10.09.

To work out where you’re going to place your stop loss, you need to work out how many times your ‘per pip’ will go into your $200 risk.

AUDUSD - $200 / $13.39 = 15 pip stop
NZDCAD - $200 / $10.09 = 20 pip stop

If you require a much wider stop loss then all you need to do is decrease your lot size – one option is to change from a standard lot to a mini lot, which is a lot size of 10,000 instead of the usual 100,000.

For one mini lot of AUD/USD, your stop loss can be 150 pips away from your entry, while for NZD/CAD, your stop loss can be 200 pips away from your entry.

Remember: there is a risk for every trade you place – always ensure you understand the risks of trading and know upfront how much you’re risking, and that you’re comfortable with it.

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