Why should Forex Traders to develop a risk-management strategy

Most forex traders are familiar with the risks of trading without a stop loss. Without such a plan as part of your risk management strategy, the market can keep moving against you until you can no longer stand the pain and are forced to take a major loss.

Without a stop in place, an initially small loss can often begin to grow, weighing on the mental state of the trader "riding it out". They are now stressing over the growing amount of the loss as the account is put at risk.

Eventually, the trader panics and possessed by the fear of losing it all, gets out of their losing position at the absolute worst price. They then typically sit on the sidelines licking their emotional wounds and watching the market make an equally strong recovery.

Unfortunately, this scenario plays itself out far too often among forex traders that do not manage their risk with discipline and according to a strict trading plan.

The Losing Trader's Mindset
The mind of that losing trader is by now mired in confusion after taking that large hit in their trading account. They may even be slightly paralyzed from taking part in further trading, and give up trading forex entirely.

Conversely, the bolder among them may be ready to risk the rest of their account in the increasingly slim hopes of making back the lost funds. Either way, the trader made a number of costly mistakes which all began by them not having the discipline to cut their losses at a prudent level in the first place.

Costly Mistakes Commonly Made
Some of the more common trading mistakes this trader made included:

  • Taking too much risk on a single trade - This mistake also includes making too large of a trade in relation to the account size. "If you can't take the heat, stay out of the kitchen," and because of the high leverage available, the forex market can get quite hot in terms of portfolio heat.
  • Trading without a stop-loss order - Because of the volatility inherent in some currency pairs, not having a stop-loss in when holding a position, is like walking along a tight-rope without a net. You might just end up wishing you had one.
  • Waiting too long to get out - This typically happens to people with a stubborn nature that think they are right, when the market clearly shows they are not. Professional traders tend to take small losses as soon as they realize their mistake. This allows them to reassess the market flexibly without bruising their ego too much so they can right jump back in.

    • Avoiding Such Mistakes
    The way to avoid making costly mistakes in the trading arena involves strictly adhering to the trading parameters of a concise, complete and well-tested trading plan. Any such plan should contain a risk-management component and be relatively easy to follow and implement in practice.

    As an additional measure of insurance, position sizing in decreasing amounts as the portfolio size decreases along with less frequency of trades and a focus on higher probability trades is recommended.

    This helps add a further cushion to the portfolio in the event your system undergoes a string of losing trades in unfavorable market conditions. While such a strategy for handling a long string of losing trades will hopefully never be used by a trader, having one in the event this dismal scenario occurs is certainly preferable to not having one at all.