Why understanding risk management is key to trading success

FOREX trading – like any trading – is not without risk, so education and a sound risk management strategy are key to achieving any level of success. Learning to manage your positions, and to understand leverage and margins, is critical.

When you open a trade (or position), it is active in your account and subject to fluctuations in the exchange rate. As such, it is imperative that you track the progress of all your open trades to manage the risk of the exchange rate moving against you. A mobile platform, like OANDA’s fxTrade Mobile, allows you stay on top of your positions throughout the trading day.

Trading in a margin account allows you to use leverage to enter into trades larger than the size of your actual balance. For example, with a ratio of 50:1, you can enter into a trade worth up to $50 for every $1 in the account. This means that, while only committing $1,000 to a trade, you have the potential to earn profits on the equivalent of a $50,000 trade. Of course, you also face the risk of losing funds based on a $50,000 trade, and these losses can add up very quickly.

Although some brokers permit margin ratios of 100:1 or more, you should consider limiting your account to a lower ratio such as 20:1 or even 10:1 until you gain trading experience. The higher the ratio, the greater the potential for losses, so it is very important to understand your broker’s rules regarding margin.

When trading on leverage, you are effectively borrowing money from your broker. The funds in your account (the minimum margin) serve as your collateral. Therefore, it is only natural that your broker will not allow your account balance to fall below the minimum margin.

When you have one or more open trades, your broker continually calculates the unrealised value of your positions to determine your Net Asset Value. If your open positions lose so much potential value that the remaining funds in your account are in danger of falling below the minimum margin limits, you could receive a margin call.

Individual brokers may handle margin calls differently. You could receive a request to add more funds to your account, or your broker may simply close your open positions at the current market price to limit further losses. In either case, you could end up losing the entire balance of your account, and may even owe additional funds to cover your losses.

To solidify your risk management strategies, start trading in a demo account. Visit www.fxtrade.co.uk to start today.

Paul Hayward is head of sales at OANDA Europe.

Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds