Forex Education
Risk
Management
There
are three basic questions that every
trader should answer BEFORE entering a
trade.
How much
do I believe the market will move and
where do I want to take my profit?
Limit
Orders allow traders to exit the market at
profit targets. If you are short (sold) a
currency pair the system will only allow
you to place a limit order below the
current market price because this is the
profit zone. Similarly if you are long
(bought) the currency pair the system will
only allow you to place a limit order
above the current market price. Limit
orders help create a disciplined trading
methodology and enable traders to walk
away from the computer without constantly
monitoring the market.
How much
am I willing to lose before I exit the
position?
Stop/Loss
orders allow traders to set an exit point
for a losing trade. If you are short a
currency pair the stop loss order should
be placed above the current market price.
If you are long the currency pair the stop
loss order should be placed below the
current market price. Stop/Loss orders
help traders control risk by capping
losses. Stop/Loss orders are
counter-intuitive because you do not want
them to be hit, however, you will be happy
that you placed them! When logic dictates
you can control greed.
Where
should I place my stop and limit orders?
As a
general rule of thumb traders should set
stop orders closer to the opening price
than limit orders. If this rule is
followed, a trader needs to be right less
than 50% of the time to be profitable. For
example, a trader that uses a 30 pip
Stop/Loss and 100 pip limit orders, needs
only to be right 1/3 of the time to make a
profit. Where the trader places the stop
and limit will depend on how risk-adverse
he is. Stop/Loss orders should not be so
tight that normal market volatility knocks
the position out. Similarly, limit orders
should reflect realistic expectation of
gains given the markets trading activity
and the length of time one wants to hold
the position.
Test Your
Skills
If
you haven't already you will need to
register for a T & K Futures Demo
account and download the Free Software.
Click here.
1.
Buy three different Euro positions.
Place a 20-point stop order, 35-point
stop order and a 100-point stop order.
2. Buy three more Euro positions. Place
a 20-point limit order, a 70-point limit
order and a 200-point limit order.
3. Buy one Yen position and place a
30-point stop order and a 100-point
limit order. Now buy one more Yen
position without a stop or limit order.
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