Too many traders do not fully understand the risk of trading, instead they focus on the percentages of profit that they expect to make. As a rough guide the greater the percentage of return expected the greater the risk you might be taking.
Any type of investment carries an element of risk. However these risks are not even. If you are trading using the brokers listed on this site they all offer leveraged products that could mean you could lose more than your deposit. Note that anywhere up to 85% of traders lose money trading.
Some key events have resulted in traders losing their full account and still owing the broker money to cover the losses (note brokers registered by the FCA have to ensure that you cannot lose more than their deposit for retail traders). Traders must ensure that they fully calculate their potential losses.
How risky is it?
There are a number of risks that newer traders are unaware of particularly in the forex markets. There is enormous amounts traded on any given day however this does not mean that for every buyer there is a seller and visa versa. At certain times larger traders stay clear of buying or selling. This leads to less liquidity, thus there can be times when you cannot exit your position at the price you want. This is referred to as slippage. This can happen around key economic news events or in the current environment when political events/speeches/twitter announcements occur.
The biggest such even in recent years was on 15th February 2015, when the Swiss National Bank (SNB) decided to unpeg their currency from the Euro. Until this point they had built up massive reserves of foreign currency in an aim to avoid the Swiss Franc being used as a safe haven. Under pressure from a risk that the Euro would have fallen further due to an expectation that the ECB would start quantitative easing resulting in a weaker Euro, the SNB took action. This resulted in a 350 pip move at one point on the eur/chf as they announced it when the market had the least liquidity. With no one being willing to be on the other side of the trade to allow brokers to close stops, this resulted in enormous losses beyond the amount of money that was in many traders accounts. This meant that these traders owed their brokers significant amounts. It also meant that for brokers that were making the market they were very exposed to this and resulted in them going out of business. Fortunately these events are rare, but you should be aware of slippage even if it is only a smaller amount with the leverage that you are offered with forex, CFDs and spread trading you can lose more than your trading pot. You are liable for any losses however caused.
What can I do to reduce the risk?
There are a number of key rules you should apply to reduce the risk of your trade, these include;-
- Ensure that you use stops.
- Ensure you only trade with a small percentage of overall trading pot.
- Ensure you know how much you could be exposed to if the trade goes against you allowing for any leverage.
- Ensure that you have done your homework and take into account any key news events that are planned
What else can I do to reduce the risk?
You should always calculate the potential reward of your trade, i.e. where you would expect price to go if your analysis works. You should also know how much risk you are exposed to if your analysis does not work on this occasion. Once you know these numbers you can look at the risk/reward ratio.
Ideally these are going to be a positive ratio in the favour of reward, i.e. you may risk 10 points to make 20. Some high probability strategies may be okay with lower ratios but the better it is in terms of reward, the more likely you will make money over the longer term.
Is there anything more that I can do to reduce the risk?
To truly understand the risk of your trade you will find that some back testing of your strategy extremely worthwhile. This could be a whole subject on its own, but we find that you build a lot of knowledge up if you can build up some history of your strategy.
A word of caution here, do not try and curve fit the strategy only to recent price action/ circumstances, look at how it works when the markets are more or less volatile.