Every Trader is looking for low risk forex trading strategies and how to save money and to increase his profit. But before you can start searching, you have to be clear about your risk. What do you mean by “low risk”? And what is the risk?
The definition of risk is very soft. Wikipedia says:
“The possibility that an actual return on an investment will be lower than the expected return.”
And Investopedia is even softer:
“The chance that an investment’s actual return will be different than expected.”
So, if you invest and expect 20% gain and you get only 15%, then it is lower than expected and that is your risk? Obviously not.
Some measurements, calculate the standard deviation of the historical returns. The conclusion: The higher the standard deviation the riskier the investment.
This is better than the first one, but it contains the past and the future can and will differ. Look at all the forecast and how they fail. My professor at the university said:
“Predictions are very difficult, especially when they concern the future.” 🙂
For me as a trader the risk is what I am willing to lose with one trade.
For example: I enter a trade and get out, when the position hits a loss at $ 100.
Depending to my capital it may be low risk (0.1% of my capital) or high risk (100% of my capital).
Why Forex for Low Risk Strategies?
One advantage of the forex market is its low entry barrier.
You can start trading in the forex market with less capital, sometimes only $1,000 Dollars.
Furthermore many brokers offer you a leverage.
With this leverage you can easily scale up your trading volume.
What requirements must be met for low risk strategies?
First and foremost, you need a stop loss for your strategy. You have to know at which loss you will close your trade. For me this is the risk you take. Due to unfavorable circumstances, for example a lost internet connection, broken computer or unexpected event, your loss might be (substantial) higher.
The second point is the leverage you take. The higher the leverage, the higher the potential gain, but also the higher and faster the potential loss. To image the impact of the leverage look at a seesaw. If you have no leverage, then both legs are equal. If you have a leverage of 1 : 10 then one leg is 10 times longer than the other. Sometimes you can use a leverage of 1 : 100 or even 1 : 400. Image, your trade moves 0.25% against you and your capital is blown away!
My advice: Use the leverage very, very carefully.
The third feature you have to look for is the volume of the market. You have to be sure, that enough money and player are in the market. in order to enable you to exit the market at any time. It is nasty, if you want to sell and nobody wants to buy. The price drops and drops and you will get a very bad fill. In hindsight your risk (loss) is much higher as wanted or even as you can afford.
The fourth item is connected to the volume. It is the spread. The Spread is the difference between the bid price and ask price. This is the main trading cost of the forex market. The spread should be as low as possible. It differs from broker to broker and market to market. The biggest forex market, the USDEUR pair has the smallest spread. As a rule of thumb, you can say, the smaller the market the higher the spread. For more details regarding trading cost look at my article: “Low cost stock trading.”
The fifth point is the time. Each forex market has its own main trading hour. The volume peaks in this time and the spread shrinks. Outside the main trading hours the spread increases and so your trading cost.
The last point are events, such as announcements from the FED or other central banks. But also major political speeches or decisions can heavily impact the forex market. In this time the market is confused and the price goes up and down like crazy. The spread breaks up and you are not able to make a low risk trade.
What are the components of a low risk forex strategy?
- Stop loss approximately 1% of your capital per trade
- Appropriate Leverage
- High Volume Trading Pairs
- Low spread
- Trading only during the main trading hours
- Avoid event with a massive impact on the market
What do you think? Do you have other points in mind? I would like to know what your experiences are. Please leave a comment. Thanks.