Today we want to focus on some general mathematical aspects of forex trading and we’ll describe some general information about risk management and how you should learn it.
Besides technical analysis and fundamental analysis, risk management is the third pillar of professional forex trading and is another aspect you should master in order to have long-term results.
How risk management affects your trading?
Most of the beginners out there, even though they do not have enough experience in the markets, just gamble their entire account on every trade. We’ve mentioned several times that investing is a game at which you won’t win 100% of time. No matter how good you are, you will still encounter losses.
Having a well-established risk management system can help you overcome those losing periods and leverage the profitable trades.
What should you consider when making a risk management system?
You can’t just pick up randomly a system for free from the internet or buy it from a forex guru. You need to shape your own risk management system based on your performance.
First and foremost, your accuracy is the one you should consider. By accuracy we mean the percentage of the profitable trades during a given period of time. You should measure and know your accuracy in order to be able to see how you should model your system.
Reward to risk ratio is the profit divided by the risk that you took. For example, if you make 100 pips on a trade and risked to lose 50 pips, the reward/risk ratio is 2/1. For a 50 pips gain with a 50 pips risk is 1/1 and so on.
Percentage of the account at risk. How much money you are risking on a percentage base, out of your entire account is another crucial aspect for effective forex trading.
In our next material we’ll talk about the risk of ruin formula and how you should use it, based on the aspects we’ve described above, in order to avoid blowing up your entire account and build up a strategy that will enable you to profit consistently.