step 2: Learn to Manage Your Risk
In our experience, the most successful traders are not simply the ones who take the best positions. They are the ones that are smartest about risk management and disciplined in their strategy. They are never emotional about gains or losses. They set their profit target and loss limits for their positions, and use Limit Orders and Stop/Loss Orders to lock them in.
Limit Orders
A limit order instructs the system to automatically exit a position when your target profit has been achieved. This enables you to "lock in" your desired profit on a winning position.
Stop/Loss Orders
A stop/loss order instructs the system to automatically exit a position when your maximum loss limit has been hit. This enables you to cap your losses on a losing position.
Trading Discipline
Professional Traders use Limit Orders and Stop/Loss Orders as the cornerstone of a disciplined trading strategy. By setting both on all their positions, they have removed emotion from the equation and are letting the market work for them.
Amateurs, on the other hand, dont use Limit Orders and Stop/Loss Orders. They stay glued to their screens, trying to juggle all their positions in real time. They miss critical action points, and they let emotion rule their decisions.
Setting Limit and Stop/Loss Orders
As a general rule of thumb, you your Stop/Loss Orders should be set closer to the opening position price than your Limit Orders. If you do this, then you can be successful while being right less than 50% of the time.
For example, if you use a 100 pip Limit Order with a 30 pip Stop/Loss Order on all your positions, then you only to be right 1/3 of the time to make a profit.
Where you place your Limit and Stop/Loss Orders will depend on your risk tolerance. However, you need to be smart when setting them. If a Stop/Loss Order is too close to the opening position price, it can be triggered by normal market volatility. This means that a temporary dip can knock out a position before it has a chance to retrace. Similarly, if a Limit Order is set too far from the opening price, potential profit may never be realized.
Be aware that trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.
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