Forex Trading

Forex trading although involves significant risk, is actually a profitable way of making money if you know how to invest wisely and practice prudent money management. Most traders often fail because they were ignorant of the risk they are taking and they never have a plan in mind and worst part is, some don’t understand even the most basic calculation. The most common mistake is always to underestimate the market and as a Forex trader myself, I can tell you that a huge swing such as movement of a few hundred pips in matter of hours in quite a common scenario especially during news announcement. So the question is, if we know the risk is there, how do we play it safe and protect our capital while at the same time continue to generate income from Forex.

First of all, one thing I always believe about Forex trading is that you must always know the risk that you are taking and knowing how to perform the most basic calculation to come up with the figures. In fact, many experienced traders will tell you that, it is best never to risk more than 5% of your account deposit in any single trade. In order to achieve that, what you need to do is to set the stop order limit and even if you are dead wrong and lose the trade, that would only mean 5% and that gives you a chance for recovery to make up the losses. To help you on these, forex tools with pip calculator come as useful, but it doesn’t hurt to understand the underlying principle to work out the calculations.

For instance, if your account has a deposit of 1000USD, a Forex broker with 10:1 leverage will allow you to trade 10 times the amount of deposit that you have which is 10000USD worth of currency. If a single lot size is traded at that amount, that means 1 pip is equivalent to 1USD. Therefore In order to stick to the 5% risk, you would have to set the stop order limit to automatically close your position when your trade starts to lose around 50 pips or about 50USD. That is just a rough estimation because there are conversions involved if you are trading non-USD pairs. Some forex traders even suggest lower risk size, which is only 2%, but I would say no matter what, it should never be over 5%.

If you have plans to engage in long-term Forex trading, I would suggest that you could also play around with the lot size that you are trading so that you can absorb wider currency swings. Let’s look back again at the example, which was mentioned above. Similarly if you have 1000USD deposit, instead of buying 10000USD worth of currency, the trade size can now be reduced to only 5000USD (mini lot size) and that means 1 pip is now roughly worth about 0.50USD instead of 1USD. By doing this, you can afford a negative swing of 100pips and only lose 50USD which is according to the 5% account risk that you are taking.

These calculations are actually not really hard to understand and is the most basic knowledge in which every forex traders need to get a grasp on and I would suggest that before you begin forex trading using real money, learn on these fundamentals and knowing how to do risk assessment.