Forex Courses on Demand

Mastering Risk Management Part 1 – The Key To Mastering Forex

Hello, and welcome to this latest edition of courses on demand brought to you by forex taught academy. So, in this course, we will be discussing the approach in, and around mastering risk management however, before we begin, and there is, of course, inherent risks in terms of trade in the financial markets. So, please do take a brief moment to familiarise yourself with our disclaimer, if you do need to stop this particular recording, and please feel free to do.


So, and we shall, as a result, we shall continue with explaining what you can expect over the course of this webinar. Okay, so, we’re going to begin with just a fairly brief introduction to risk management we will then look at the principle of conviction trading, and, how that impacts a person’s approach to broadly speaking let’s say to risk management then we’ll have a look at specifically risk-reward ratios, and obviously, how that, and those principles can impact your approach to risk then we will be looking at notional travel size which is one aspect to trade the financial markets which most new, and inexperienced traders have very little understanding of. So, we try to explain that to you at this very introductory level will then look at trading exposure levels we look at risk tolerance, and the importance of accuracy when you’re trading especially with regards to risk is actually something that should be quite important for every trader’s toolkit, and finally we’ll finish with just looking at the psychology behind risk okay. So, let’s start straight away then with a brief introduction to risk management, and let’s start by giving you a basic definition, and risk management is the forecasting of evaluation of financial risks together with the identification of procedures to avoid or minimise the down side-impact. So, this is particularly important. So, risk management as far as a trader is concerned should I say is their ability to do one of three things, and it’s just expanding in a little bit more detail firstly it’s all about a traders ability to firstly assess, and quantify the potential for loss. So, how much of their capital are they putting on the line in order to perhaps get involved in that potential investment or trade. So, that’s the first thing that’s quite important. The second thing is to then actively manage the potential for losses on an ongoing basis. So, it’s not just that from the outset it’s as things evolve, and as things change will there be decisions that will need to be made to regarding to protect your capital, and once you happen to be in that particular form of investment, and then the third thing in terms of what risk management is all about it’s about a trainers ability to mitigate that potential loss. So, if you can get an opportunity where you can take you any potential loss off the table, then obviously from a psychological perspective as well, that’s a very good position to be in. So, those are the three major elements, which is what risk management is all about. It’s about a trader’s ability to assess to manage and to mitigate potential losses. So, consistently in it is a point worth making, and hopefully you’ll take this on board but consistently profitable traders owe their ongoing success to their understanding appreciation, and implementation of a risk management strategy however certainly in our educational experience as well if nothing else it doesn’t particularly figure that highly in the list priorities for all other traders, ie those that are not necessarily consistently profitable. So, there is a common denominator with those that are able to generate consistent returns, and that is because they’ve they’re acutely aware of the importance of risk management either from a protecting their own capital perspective and but also in their ability to generate those consistent returns on an ongoing basis. Now, a stop-loss I’m sure you’re all very aware of what a stop-loss is, but it is effectively a traders metaphorical line in the sand which states for example if a trade pulls back to a certain price then I as a trader no longer want to be in that particular trade. Now, this is a very powerful, and strong risk management approach in something worth taking notice of ok.

So, that was just a brief introduction to risk management. So, what works hand-in-hand is something which it’s very important first a certain number of traders out there, and it’s really the conviction they have for a particular trade. So, talking about conviction trading, and let’s start with a definition, it’s simply a strongly held belief or opinion to achieve the desired outcome. So, conviction trading is built on the principle that each, and every trade has different characteristics, therefore, should not make set should it not make sense to apply a one-size-fits-all approach to each, and every trade. So, that doesn’t necessarily seem to make much sense. So, what you need to do is to find a way to rate the potential for each, and every trade, and almost cherry-pick the trades which you have a strong held belief that you will see, and achieve a certain positive outcome from, and it’s really that’s what conviction trading is all about. So, the key is to look for higher conviction trade setups. Now, an easy way to categorise whether a trade is a higher conviction trade setups is for looking for the specific reasons to get into that trade. The more reasons you can identify to take a particular trade as a result normally, the stronger your conviction will be for that particular trade. So, one important skill to develop when it comes to your approach with regards to conviction without a doubt is actually patience. So, you might be identifying a particular set up it might not be fully formed you may need to be patient, and wait for that setup to realise itself because a lot could happen in between, and try not to preempt you know often trade in financial markets for a lot of technical traders as using a variety of indicators to trade what they see, and often when you get those setups [Music] it’s then about an issue of timing actually, and on occasion you are required to be somewhat patient, and wait for that final confirmation. So, hopefully, that makes a little bit of sense that’s a little bit about conviction trading. Now, moving on to risk-reward ratios. So, there’s two major types of risk-reward ratios, and the first one is a positive risk-reward ratio. So, this is when a trader makes consistently more money on a trade when they win than when they lose. So, let me give you a little example of this. So, if we have a trader who’s making a hundred euro every time they win however, when they take a loss, they realise a fifty euro loss each time they take that loss. Now, this is a trader that’s adopting a positive risk-reward approach. So, the wins are greater than the losses, and this just happens to be a positive two-to-one risk-reward in this particular case. So, this particular trader can lose two trades, and if the third traders of winner he will effectively break even on his on his capital. So, that’s positive risk reward. So, the opposite of positive risk reward is adopting a trading strategy, and approach which is referred to as a negative risk reward ratio. So, this is when you consistently make less on a trade when you win then when you lose. So, let me give you this example once more. So, let’s just say a trader makes 50 euro every time they win on this occasion however when they take a losing trade they actually lose 100 euro every time they lose, and on this situation it’s a it’s a trading approach, and I’m sure there is a lot of traders which adopt this kind of approach but what they’re effectively doing is operating a two-to-one negative risk reward approach. So, that’s worth taking on board. Now, there is a lot of traders that do trade both types of approaches however with a negative risk reward ratio the impact can be, and significantly psychologically quite damaging if that is the type of trading approach you happen to be adopting. So, you can imagine if you take let’s say five back-to-back losing trades which can happen every trader will experience a losing streak. Now, that might become a considerable uphill challenge them to realise the 500 euro loss in this situation, and realise that they will need to get ten back-to-back trades in order to even break winning trades that is in order to even break even on their capital, and that can put quite an onerous psychological negativity I guess to an approach it can it can change perhaps your the way that you’re interacting with the markets you might take on a little bit more risk.

Now, to try and chase those five losing trades, and you’ve only had five losing trades you know that’s not beyond the realms of possibility, and all of a sudden you’ll start changing your approach you’ll start taking on more risk, and that’s when an approach like this you know can become a little bit more dangerous. Now, it is possible to make money from both approaches however please do be careful all high-percentage win rate strategies normally operate a negative risk reward ratio. So, they might suggest, and suggest that you know this particular approach is at 80 or 90, and 95% win rate that’s absolutely fine but as far as risk reward ratios are concerned that very well may be the case but the likelihood is with an approach like that their risk exposure to the downside might be considerably greater than the number of trades that they enter, and the fact that they take out profits a lot more often than not. So, you can make obviously money adopting both approaches, and you just need to be very aware of the pros, and of each type of risk reward ratio if you do. So, okay. So, moving on then to notional trade size or n TS for short, and let me start by giving you a brief definition. So, notion of trade size is the overall position size value of a leveraged trade where in a small amount of invested money can control a much larger position in the markets accurately calculating trade size is an important component of a solid risk management strategy. So, to break this down in a little bit more detail for you, and putting this into fairly simple terms the notional trade size of a trade is is the actual value of size of that trade if you are trading without leverage. So, it’s it’s very common for most retail traders to trade with leverage it allows traders to access markets which they would not ordinarily be able to access. So, leverage can have its benefits but therein lies some of the potential issues as well with access that what we often what some traders experience is because of a lack of education, and understanding about what they’re doing in these markets leverage can become kind of a double-edged sword for some. Now, whatever actual trade size you happen to be trading on a leveraged product you will also be trading a notional trade size as well. So, if you happen to take a 10 min trade in the euro dollar for example then that will also have a notional trade size, and the problem is most traders do not necessarily have a particular understanding about notional trade size they focus on the trade size which they see in front of them, and which they identify with relatively quickly however it is a very useful thing to know just because what you can do when you’re trading you can get you can make sort of errors especially when you start out trading these markets but if you have an understanding of notional trade size, and then you can often identify the perhaps that the side the notional trade size of the trade doesn’t look right it doesn’t it doesn’t fit with your kind of your normal notional trade sizes, and it’s just a very useful aspect for I trader to have a little bit of understanding about. So, it’s very useful to know. So, just to explain it in a little bit more detail, and we just got three markets up on the screen. So, the first one is the example of market is a Forex pair. So, just take for example at the Euro Dollar, and the notion of trade size for a 1 lakh trade or a 1.00 volume on a Metatrader 4 platform is actually a hundred thousand of the base currency, and what this means is when we trade foreign exchange the first three letters the EU are refers to the base currency, and the second three refer to the quote currency. So, when traders actually trade ‪the‬ ‪foreign exchange markets they’re trading‬ one currency against the other, and the base currency is the trade size that they’re looking to trade often the price well it’s it’s for a fact the price that you will be trading euros in is the quoted price on the metatrader4 charts for example. So, you have the base currency, and then you have the currency that the value is quoted in, and that’s referred to as the quote currency.

So, in this example one standard lot size of foreign exchange if you’re trading a euro dollar is a hundred thousand euros. Now, of course that is the notional trade size. Now, because of leverage you’ll be trading a much a small proportion of that capital but that is again the benefit of leverage enabling you to access a trade of that size with much less capital to be able to do. So, hopefully this makes sense, and to just slide it across as you can see you can also trade, and different portions are of 1:1 standard luck, and on a Metatrader 4 platform in this occasion you could also trade ‪1/10‬ of a standard luck which is zero point one zero, and what that transpires from a notional trade perspective is this time instead of 100,000, and a base currency. Now, you’re effectively trading 10,000 euros worth of US dollars, and this is also referred to as mini lots as well. So, you have a standard lot you have mini lots, and you also have micro lots. So, without going into too much detail as far as that’s concerned because we’re just focusing on notional trade size right. Now, if you happen to trade a 0.01 locked raid on a Metatrader 4 platform, and you’re trading a euro dollar what you’re effective from a notional train size is accessing a notional trade size of 1,000 euros worth of base currency. So, if you trade a 0.01 lot of the euro dollar you will effectively be trading 1,000 euros worth of US dollar at whatever particular price you happen to take at that time. So, that’s just a broad overview, and in terms of notion of trade size, and, how that can change depending on the size of the trade in which your you’re trading. So, applying that to different markets for example the footsie, and it does vary for market to market. So, this is this is something that you will learn with experience no doubt but let’s take a foot see trade for example this time. So, this is a global indicee. So, again if we’re trading one standard luck, and will effectively be trading one pound in terms of a notional trade size. So, this is a without the desire to confuse you too much let’s just say for one standard lot size you’ll be trading effectively one pound if you’re trading as zero point one zero valium on a Metatrader 4 platform you’ll effectively be trading 10 pence, and finally if you happen to be trading a 0.01 lot on the footsie market you’ll actually be trading at a notional trade size of 0.01 which is a 1 pence trade. So, taking that across to different markets you can see, how these markets vary quite drastically depending on what market it is you happen to be trading a 1 lakh trade in the gold market, and would transpire as a 1.00 volume on a Metatrader 4 platform the notion of trade size is effectively 100 ounces of gold in this particular example moving along the zero point zero sorry zero point one zero volume on a Metatrader 4 platform would give you a notional trade size of 10 ounces of gold, and finally one micro lot or 0.01 volume on a Metatrader 4 platform if you’re trading gold would mean that you are effectively trading one ounce of gold. So, hopefully that makes sense that just gives you a sample of a different market in a few different asset classes. So, I hope that does make some sense ok. So, just um just to reiterate just having an understanding of notion of trade size is just a very useful tool from a knowledge, and understanding perspective when a trade is trading these markets ok. So, moving on then to trading exposure levels, and these are very important for traders because an individual exposure level is the amount of capital you are risking in each individual trade. So, for example if we happen to be trading a 2% trade of a 10,000 US dollar trading account what you are effectively doing is exposing approximately $200 of your trading account. So, it’s quite a straightforward calculation. Now, where things become a little bit more difficult is with regards to overall exposure levels so. Now, this is the total amount of capital you are risking in all open trades combined at any one time.

So, let me give you a good example let’s say we happen to be trading six open trades, and we happen to be risking approximately 3% per trade. So, what that means, and if all of those six trades are open at the same time, and you’re still exposed to that amount of risk what it means is you’re you’re effectively risking eighteen hundred US dollars of your 10,000 account balance is the amount of your capital which is exposed not taken into account any any particular issues with regards to to slippage or anything of that nature which means that your exposure could actually be potentially more than the one thousand eight hundred US dollar, and currently on screen but what it does is it gives you a bit of a better understanding that for all intents, and purposes if all those trades move against you you’re actually exposing about 20 percent of your trading account. Now, the problem is this is not really what retail traders pay that much attention to or they certainly don’t pay enough attention to this. So, then they think of each individual trade individually but in actual fact if you are exposing capital in all of those trades then the overall exposure is something that should be a consideration. So, this is what retail traders do not pay enough attention to they stay disciplined on the individual trade size often ignoring what their overall exposure to the market is if all trades go against them, and it’s that ignorance are perhaps ignoring the overall exposure is why a lot of traders can really come unstuck. So, it definitely worth giving some thought to. So, moving on then to risk tolerance. So,, how much should a trader risk per trade is often a question especially for those that are starting out, and trading the financial markets, and unfortunately the answer is that it depends on the traders risk profile. So, what we mean by this is let’s just take a little chart just in the middle of your screen there where what we’ll have going down the y-axis is a traders approach to risk, and perhaps along the x-axis along the bottom we might have a traders approach to return, and of course with each aspect whether it’s risk will have those traders that am within their personality in there their genetics they’ll have a higher profile to risk or perhaps be a little bit more risk-averse the same with regards to return there is all types of traders out there some have a very low expectation when it comes to return, and some have a very high expectation when it comes to return, and this is why this question is a very difficult one to answer because it depends on the traders risk profile, and of course that is a very individual decision to make but what you can see currently from what’s up on screen is that you will experience a significant move whether you are someone that wants okay. So, moving on to risk tolerance. Now, and a question that is very common is, how much should a trader risk per trade the answer unfortunately is that it depends on the traders risk profile. So, let me share this graph with you. So, let’s start with the y axis on the left hand side there which is the traders approach to risk, and along the x axis let’s look at a traders approach to return, and the problem you have with each, and each individual traders they’ll have a very different risk profile from a low sort of more risk-averse approach to taking risks with their capital to those people that are quite happy to take higher risks when they trade, and the same as with regards to return. So, they’ll have some people will have a lower expectation of return, and some people of course will have a much higher expectation return, and the problem is that will change over time depending on your approach to risk, and, how much return you want in exchange for that risk, and what you generally find is those that are quite happy to risk less are quite in general happy to see a lower return whereas those that will take higher risk when they trade to financial markets are therefore looking, and interested in seeing, and achieving a much higher return for their time, and their effort, and a capital that they’re putting on the line. So, just as a brief sort of bit of information for you for those of you that are new, and inexperienced traders it’s always advisable to start with a low risk low return approach to gain the experience necessary before taking on more risk. So, hopefully that’s a common-sense approach. So, do bear that in mind, and really the reason why this question is. So, difficult to answer is because it depends on a traders risk profile depends where you place yourself with regards to your approach from risk to return. So, wherever on that scale you might be placed is really the answer to that question, how much should a trader risk per trade it’s a very individual decision to make depending on your on your risk to reward profile okay. So, moving on then to just to accuracy risk management strategies should be based on accuracy in our opinion knowing exact entry, and exit prices, and the size of the trade you wish to take, and, how many pips are capital you happen to be exposing in a trade is all very important. Now, a common problem for retail traders there’s a couple of them lack of it, and to give you a practical example trading a higher risk percentage per trade, and then intended is it is an issue that a certain cohort of traders will experience because they decide to ignore the principles of accuracy. So, for example they happen to be trading a 1000 euro account in this example they intended to risk just 20 euro at a 2% of their capital but in reality, and they’ll realise this when they when they look at their journal order P&L; in reality they were effectively risking 30 euro per trade actually at a much higher percentage, and it’s because they were perhaps very lacks or very careless about the size of the trade in which they were taking, and perhaps they didn’t consider the stop-loss placement to well whatever the case may be because they weren’t particularly accurate in their approach they decided to take a series of decisions, and then ultimately realise that they’ve actually been overtraining they’ve been trading at higher sizes than they actually intended on.

So, again it’s a very common problem for retail traders, and another common problem is trading on this occasion a lower percentage per trade than intended. So, for example this time we’ve still got the trader with a thousand-euro account, and they intended to risk 20 euro per trade which again is the 2% of their trading account but in actual fact they were under trading in this example, and they were actually seeing losses of approximately 10 euro let’s say, and in reality they were actually trading at 1% when they actually intended to trade a higher percentage than that. So, it can it can work both ways. So, it is important to try to maintain a certain degree of accuracy when your trade always trade at a predetermined risk percentage perhaps when you trade, and try to be accurate, and disciplined it in everything you do, and that is just a generic overview and. So, just to finish off then with the psychology of risk. So, it’s fairly common there’s three key reasons why new traders do have difficulties, and this is very much anecdotal but they it’s quite important at the same time, and the first one is they don’t have a trading strategy, and I mean that I mean that in the kindest possible sense because the trading strategies should help you be able to determine what trays you should select where you should enter those markets weigh should exit those markets, and of course give you some assistance with regards to timing how, and why you should get into those trades at those particular moments, and if a trader can’t answer all of those questions, and then what they’re actually doing is guess thing with every decision they make, and there are lies some of the difficulties that trader coming can encounter the second one. Now, is that they don’t really have firstly an understanding of risk management but they definitely don’t have a strategy which they’re looking to implement to any great extent, and of course that’s what this whole particular webinar is all about. So, no risk management strategy is a major issue, and something that new traders have significant difficulties with, and then the third, and final point is that are not mentally prepared to trade volatile markets maybe they don’t understand, how volatile some of these major global liquid markets are, and but they get into the markets they may be trade at much smaller timeframes, and they’re finding those markets very volatile you know big swings very difficult to understand what’s happening, and, how to navigate those markets, and what all of these things will elicit in traders from a psychological perspective is a whole range of emotions for example fear, and greed will also have guilt in there perhaps you’ve you’ve taken a much bigger trade sighs than perhaps you anticipated maybe because you have elements of greed as well, and you thought this is a, and no a no brainer trade for example when you thought you can clean up on this particular trade, and maybe didn’t go quite well for you, and then you’re suffering with that level of guilt which might impact some future decisions that you’d be looking to make, and same with elation those that go through a winnings free can be absolutely delight with themselves they might let whatever got them that success they might let that drop ego starts to play a particularly important role especially with a certain core of trader, and that can have its own concerns confidence of course your confidence can be affected positively, and obviously negatively anxiety you know lynx works hand-in-hand with fear, and anxiety, and just your general mood whether it’s sad or happy. So, these are all the impacts that these particular three reasons why traders have difficulties, and and this all of these aspects linked to the psychology of risk. So, it’s just important that you try to I guess I guess embrace the major reasons why new traders do have difficulties, and look to start to address them as best you possibly can. So, just to finish then there are a number of things that a trader can absolutely do to reduce the impact that negative psychology can have on you when you happen to be trading these markets, and the first thing is try to remain objective. So, and what we mean by that is subjectivity can be a little bit on the dangerous side. So, if you have a method to remain as objective as you can that will definitely benefit you take into account market conditions, and your conviction of the trade setup. So, if you have an understanding of whether the market is range-bound whether we are bouncing from highs to lows whether the price action is quite choppy at this moment in time then that should begin to prepare yourself for a potentially continuation of that, and prepare yourself mentally as well for those types of conditions, and of course the conviction of the trade setup itself is quite important.

So, if you are able to stack a lot of reasons why you should be getting into that trade in favour of that trade you’ll feel a little bit more positive about it if you are getting into a trade with very little conviction or a low conviction status for that trade then you know your psychology won’t necessarily be that great because you shouldn’t really have major expectations of a successful outcome in those in that situation try to be accurate as we’ve discussed, and be precise with things like your entry levels, and your stop-loss placements, and things like that because again that is something that a lot of successful traders have in common they know exactly what their approach is regarding their ability to enter those markets but also their ability to protect their capital as well. So, do have an understanding as well of as we’ve discussed individual, and overall trade exposure levels that will assist you with having the more control you have over your exposure the more comfortable you’ll feel about the decisions you’re making, and it’s all about knowledge, and understanding about what you’re doing, and, how you’re conducting yourself. Now, losses are inevitable with every trading strategy is important to know that. Now, it’s it can be fairly a bit of a no-brainer to just try to control them if you possibly can try, and mitigate them wherever possible obviously that’s not always possible, and but in terms of an approach to losses you know if you can accept that they’re an inevitable part of everyone’s trading approach then that should make it a little bit psychologically easier for you strategically wait for the markets to come to you if you possibly can, and never force trades you know never have live with that anxiety, and stress, and fear of needing to get into that trade just in case you miss it because that that’s not really a good position to be in certainly from a psychological perspective whereas if you have a nice calm, and considered approach where whatever you do you wait for the markets to come to you before you make that decision, and then you put yourself psychologically in it in a much better position, and finally try to work within a risk/reward framework. So, that’s whether your approach is a low risk low return or it might be a medium risk medium return approach whatever the case may be have a basic understanding about what you’re looking to achieve, and if you can achieve, and what you set out then you’re doing very well in this environment, and that’ll really be worthwhile continuing to practice that okay. So, that’s just touching upon the psychology of risk. So, what we’ve covered in this webinar is an introduction to risk management we’ve looked at conviction training risk reward ratios notion of trade size trading exposure levels risk tolerance accuracy psychology also of risk. So, all that’s left me to do is to thank you very much for joining us on this latest instalment of course on-demand which have been brought to you by Forex Academy we hope you benefit from it, and we look forward to seeing you soon bye for now.


By Keiran

Forex trader, media, marketing, entrepreneur and father

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