How to Manage Risk in Forex Trading

Each trading session is marked by a significant, even disturbing, number of financial events. It is therefore important for those new to the forex market to stay constantly informed from reliable sources of information.

Reading the financial news allows, among other things, to understand the orientation of an economy and a national currency. Similarly, stock market investors can keep abreast of developments in listed companies. Those who prefer this type of fundamental analysis can often base their trading and investment decisions in part on new developments, and it is important to pay equal attention to risk management.

Risk management is a great way to adapt to ever-changing market conditions, where nothing is ever taken for granted. Understanding this principle from the start will reduce the stress you may feel while trading and investing. Sure, there is historical data that makes asset movements more transparent, as well as chartist techniques that use statistics to predict and model the potential direction of a price, but what happens when the outcome is unexpected?

Expect the unexpected

The secret to risk management is to expect the unexpected.

To illustrate this in more detail, consider a scenario where the UK is about to release its latest quarterly gross domestic product (GDP) results. When researching possible outcomes, you may encounter varying market consensus from rating agencies such as Moody’s or analyst consensus collected by news agencies such as Reuters and Dow Jones News. In addition, public authorities publish annual growth forecasts that form the basis for the analysts’ calculations. Examples of market consensus can be seen on our Forex Calendar, available on Admiral’s website.

As you can see, there is plenty of information to base your decisions on trading the British pound under the UK economic growth results. Although market expectations are the result of great expertise and the results can be precise, it is always possible to deviate from expectations.

If the market consensus was that the UK economy should grow by 2% in the second quarter, and the actual result is 1.95%, the gap is enough to raise concerns about the value of the pound sterling among investors. There may be a sell-off on the currency, meaning that even if you expected 2% growth and opened a position for the GBP to rise accordingly, the currency fell because the actual result was lower than expected.

Determine stop loss levels

There is no doubt that the solution for this type of scenario (used earlier) is to always set a stop-loss level so that you are not caught off guard in the event of a sell-off when you had anticipated the opposite. Just as there are many opinions about the outcome of a trading or investment event, there are also several ways to determine where to place your stop-loss levels.

Some believe that the most effective technique is to set a stop-loss level that is not too far from your entry point in case of the unexpected, the idea being to exit the position as quickly as possible. Another approach is to set stop-losses based on a specific percentage that reflects your risk appetite. A third approach is to check the instrument’s last support level and set the stop loss in the same range.

Hedging your position

The principle of hedging consists in considering a position from different angles. Suppose the Non-Farm Payrolls (NFPs) announcement comes tomorrow and the market expects the report to indicate strong growth in the US labor market. It can be assumed that if the actual results are in line with market expectations, the dollar may strengthen.

On the other hand, it is possible that the results will be lower than expected.

Gold and the dollar are inversely correlated, meaning that when the dollar rises, spot gold prices (generally) fall because these assets are considered safe havens and serve as international reserves. The dollar is favored when the US economy shows signs of growth, such as a strong labor market. In this situation, a trader may decide to hedge their USD position by taking a gold position using a CFD in their Admirals trading account.

In this scenario, a hedge would be to take a long (long) position in gold and USD and include a stop-loss on the two underlying assets. If the NFP figures are lower than expected, the USD may fall and the position will close at the stop-loss level. At the same time, the gold price may rise as traders shift their risk appetite to the precious metal, and trading may develop as expected.

As you can see from the examples above, trading requires research and skill. At Admirals, we’ve created an infrastructure with the educational resources, webinars and market analysis you need to get started.

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This content does not and should in no way be interpreted as containing investment advice or recommendations, an offer or a solicitation to trade in financial instruments. Please note that this marketing communication is not a reliable indicator of any current or future performance as circumstances may change over time. Before making any investment decision, you should seek the advice of independent financial advisors to ensure that you fully understand the risks involved.

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