USE STOP ORDERS

Stop orders are a useful forex risk management tool as they are designed to automatically close a forex position should prices move adversely and the position suffer loss. The amount of loss to be tolerated prior to closing the position is, in turn, determined by the forex trading plan. While almost always effective, the trader should realize that there may be times, such as during fast markets, when a stop order may not be able to close a position at the predetermined price but only at a worse price in which case loss on the position will be greater than anticipated.

REDUCE THE LEVERAGE

High leverage, meaning that a relatively small amount of trading capital enables the buying or selling of a contract of much greater notional value, is what makes forex trading risky. A leverage of 100:1, which is commonly available in the retail forex market, means that the trader only needs to maintain as margin one percent of the notional value of the traded contract. Consequently, a minor one percent change in price of the contract will either double the margin or wipe it out completely, depending upon the direction. It is not uncommon to see a one percent or more price change within the same trading day for many currency pairs.

Just because high margin is available does not mean that the trader has to use it. For example, the trader can establish positions as if leverage were 50:1 or even 25:1 by simply reducing accordingly the size of the position traded per unit of margin. In the former case, $1,000 cash would be held as margin for a forex position worth $50,000 and in the latter case, for a position worth only $25,000. Reducing the leverage is the same thing as maintaining excess margin above what would be required if the position being traded were leveraged at 100:1.

AVOID VOLATILE MOMENTS

Forex trading can become especially volatile in the moments surrounding the release of an important news item or economic statistic, such as the release of the monetary policy statement following a scheduled meeting of the Federal Reserve Board or the release of monthly U.S. employment numbers. In these cases, prices can move very quickly, even gap or jump from one level to another, and this will compromise the effectiveness of stop-loss orders that protect an open position. A trader can eliminate this risk by closing all forex positions prior to the event.

AVOID THE WEEKEND

Following the weekend, a forex price may open at a price significantly different from its Friday close. Any such gap in price movement will compromise the effectiveness of a stop order that protects an open position. A trader can eliminate this risk by closing all forex positions prior to the weekend. The same is true for widespread holidays.