Risk Management and Trading Psychology

Now that you know the basics of how to trade forex, we can finally get into the subject of how to actually succeed. You might think that success mostly depends on your ability to interpret charts and understand the behavior of price.

But actually, that’s the easy part.

The most difficult thing to do in forex trading is to maintain discipline while dealing with emotions. This section of the guide will give you some tips on how to do that.

Risk Management​

Time and time again, studies have shown that the majority of trades are closed out at a profit. And yet, the majority of retail traders lose money over the long run. How is this possible?

The answer is that most traders lose more on their losing trades than they win on their winning trades.

There’s something about human beings that makes it difficult for us to accept losses or allow ourselves to win.

If a trade goes against us, we have a tendency to let it run and magnify our losses. If a trade goes for us, we have a tendency to exit quickly so as to make sure that we don’t lose the small gains we’ve achieved.

Over the long-run, this causes us to consistently lose more than we win. In this circumstance, even if we win more than half of our trades, we still lose money.

It’s just human nature.

Luckily, it can be overcome through risk management. So here’s how to do that.

Trading capital

The first thing you need to do to manage risk is to make sure you have enough money in your account to be able to trade with.

Many forex brokers will allow you to start with just $25. This is because they offer leverage, which allows you to trade massive amounts of currency with a tiny amount of capital.

I’ll talk more about leverage later. But for now, let’s just say that $25 is not enough money to trade forex successfully with.

Position size

Once you’re sure that you’ve got enough capital in the account, you still need to determine how many lots to buy or sell in a particular trade.

((trading capital X maximum risk per trade) / number of pips risked)/ number of pips per standard lot) = correct position size

You’re not a mathematician? Oh, OK. Just use this position size calculator from Myfxbook then.


Placing your stop-loss in the correct place can be tricky.

Place it too close to your entry point and you will get whipsawed. Place it too far away and you will lose too much on your bad trades.

Here are two ways to get it just right:

  • Use areas of support and resistance.
  • Use volatility. Use the Average True Range (ATR) indicator to figure out how volatile the currency has been recently. Place your stop that many pips away from the entry point.

Understanding Leverage

Most forex brokers offer leverage. This means they will allow you to buy a certain amount of currency with only a fraction of the money that is otherwise needed to buy it.

This might sound wonderful until you realize that your wins or losses come out of the remaining money in your account.

Risk/Reward Ratio

The final principle of risk management is to never trade when there is less than a 1:1 risk/reward ratio.

In most cases, it’s best to trade only where there is at least a 2:1 risk/reward ratio.

Trading Psychology​

In addition to risk management, the other key to being successful at forex trading over the long-run is understanding trading psychology.

In the rest of your life, you probably believe that you will be rewarded based on what you do. If you are productive, for example, you expect to make money. And if you are nice to other people, you expect them to be nice to you.

The forex market doesn’t care how productive you are.

In fact, it often rewards people who are the least productive…people whose lives are filled with concerns other than forex and who only check their charts once or twice a day.

The forex market often dishes out profits or losses in a way that seems to defy reason.

But the more you try to force the market to give you profits, the more you lose.

The solution is to realize that you have no control over the markets.

And success in forex doesn’t come from being able to predict where the market is going. No one knows and no one can know.

On the contrary, there’s a high degree of randomness to the markets. And success comes from putting yourself in a place where these random events can provide you with riches. But only after they first cause you to lose over and over again.

But at the same time, you do have some control over how much money you make in trading over the long-run.

How good of a trader you were today does not depend on how much money you made today…it depends on whether you traded well today. In the long-run, trading well is all that matters in trading. The money is just a byproduct of it.

Now that you know how to be successful at trading, let’s discuss how to get set up with a broker.