Lesson 6: Basics of Risk Management
6.1 What Is Risk Management?
Risk management is one of the most important skills every trader must master. It focuses on identifying factors that could negatively impact a trade and taking steps to reduce their effect as much as possible.
The key difference between trading and gambling is risk management. While all trading involves risk, successful traders recognise those risks and actively manage them instead of relying on luck or speculation.
6.2 How Does Risk Management Work in Forex?
In forex trading, risk management involves setting clear rules and protective actions before entering a trade.
The goal is not to eliminate risk, but to:
Minimise potential losses
Maximise potential returns
Maintain long-term consistency
Effective risk management starts with understanding:
What you are trading
Why you are trading
What could go wrong
How much you are willing to lose
6.3 Common Risks in Forex Trading
Liquidity Risk
Liquidity measures how easily a currency pair can be traded.
Major pairs like EUR/USD have high liquidity
Minor and exotic pairs have lower liquidity
Low liquidity can cause:
High spreads
Slippage
Delayed order execution
Broker Risk
Broker risk relates to the reliability of your trading platform, including:
Platform stability
Execution speed
Account security
Anti-fraud measures
Always choose a regulated and reputable broker.
Market Risk
Market risk arises from price volatility caused by:
Economic data releases
Political events
Interest rate changes
Wars, tariffs, or global crises
Country & Social Risk
Currencies are directly linked to their countries.
Risks may arise from:
Political instability
Economic collapse
Social unrest, protests, or wars
These events can significantly impact currency values.
6.4 How Forex Traders Manage Risk
Proper Use of Leverage
Leverage allows traders to control larger positions with smaller capital.
Example:
100:1 leverage → $1,000 controls $100,000
1 pip move on a standard lot = $10
Leverage magnifies both profits and losses
Use leverage carefully and always calculate potential loss.
Proper Trade Allocation
Never risk too much on a single trade.
General rule: Risk no more than 3% of your total capital per trade
Example:
Account balance: $20,000
Maximum risk per trade: $600
Using Stop Loss Orders
A stop loss automatically closes a trade when price reaches a set level.
Benefits:
Limits losses
Removes emotional decision-making
Protects against sudden market moves
During extreme volatility, stop losses may not always execute perfectly—but they remain a vital risk management tool.
Taking Profits
Knowing when to exit a profitable trade is just as important as entering one.
Markets move fast
Profits can disappear quickly
Take-profit orders help lock in gains automatically
6.5 Understanding Risk-Reward Ratio
The risk-reward ratio compares how much you risk versus how much you aim to gain.
Example:
Risk $100 to make $200 → 1:2 ratio
Formula:
There is no “perfect” ratio—it depends on:
Strategy
Market conditions
Timeframe
6.6 The Importance of a Trading Plan
A trading plan is a structured set of rules that guides your trading decisions.
A solid trading plan includes:
Entry and exit rules
Risk per trade
Position sizing
Market conditions
Emotional discipline rules
You can also combine it with a trading journal to record:
Trades taken
Wins and losses
Lessons learned
Strategy performance
This helps you improve over time and avoid repeating mistakes.
Module Recap
Risk management separates traders from gamblers
Always control leverage and position size
Never risk more than a small percentage of your capital
Use stop losses and take profits consistently
Understand and apply risk-reward ratios
Follow a clear, written trading plan