By Sean Hyman Speculative investors love the Forex market because it allows you to control a large amount of currency with a relatively low investment on each trade. In other words, this market allows you to use leverage to go for larger gains.

Of course, leverage cuts both ways. Yes, it gives you the opportunity to magnify your gains much faster and provides a strategy to minimize your losses. But leverage can also make you lose more on your trades quicker than your average non-leveraged investment.

Fortunately, there’s a way to minimize this risk – and still go after the larger, leveraged gains. Today I want to show you how.

Tip #1: Place the Right Stop-Loss for Each Pair

As we’ve discussed before, you should ALWAYS place a stop-loss on every single Forex trade. But that’s only the first step. You also need to think about where you’re placing your stop-loss.

When minimizing risk, some traders make the mistake of putting the exact same stop-loss on every pair they trade. They never take into account that different currency pairs have different levels of volatility. Some currency pairs commonly shoot up (or down) as much as 300 pips in a single day, while others generally move 50 – 100 pips.

That makes a huge difference, and you need to take this into account when you’re trading. Let’s take a look, for instance, at the daily charts of AUD/USD (left) and GBP/JPY (right) and measure their volatilities with the ATR (Average True Range) indicator.

GBP/JPY Trades Twice What the AUD/USD Does!

As it turns out, while they look somewhat similar on the chart, the British pound/Japanese yen (GBP/JPY) trades DOUBLE the number of pips that Australian dollar/U.S. dollar (AUD/USD) does each day on average.

So let’s say you like to place a 40-pip stop-loss to be safe. That might work on a pair like the AUD/USD that trades 174 pips a day. But it’s NOT a good idea if you’re trading a pair that zips up and down 352 pips in a day like the GBP/JPY.

Think about it. You are twice as likely to get kicked out of your trade with the GBP/JPY. And if you get stopped out of your trade, then you can never make any profits.

So, instead, look at the volatility for each pair before you set your stop distance. This is what the pros do. It’s pretty easy to figure out how volatile a pair is – simply look at the average true range (which is at the bottom of these charts above) for each pair.

Tip #2: Don’t Bet the Farm on Any One Trade

The pros also take this risk management one step further. First they set the appropriate stop, and then, they only risk 1-5% of their account at any one time.

So, let’s say that you decided you should place a 100 pip stop on the AUD/USD and a 200 pip stop on the GBP/JPY. Currently, you have a US$5,000 trading account, and following this risk management model, you’re only planning to risk 5% of their trading capital on the trade.

That means you could risk US$250 of their capital. This risk would be the difference between your entry (where you got in) and your stop level.

If the AUD/USD stop is 100 pips away (which is US$100 per mini lot of risk), then we can buy two mini lots of AUD/USD and stay within that risk.

However, if you’re trading the GBP/JPY pair with a 200 pip stop (to account for it being doubly volatile), then you would only trade one mini lot of that pair to stay within your risk parameters.

Note: When you have a smaller trading account, you generally have to risk more (closer to 5%) for any trade to be worth your while. With a larger account, you have more freedom to take smaller risks (1-2%), and still make money on your trade. Therefore, the larger your account balance the better chance you have of making a go of it.

So think about risk on two levels: 1) Risk per each currency pair 2) Risk percent of your trading account. Combine those two and stay within the risk parameters of both and you will find yourself assessing risk like a pro.

Risk management is the biggest key to your success in trading. It’s not enough to call the right direction in the trade. The risk has to be properly managed or you will empty out the whole account.

Word to the wise…manage your risk first and foremost!

Best Regards,
Sean

EDITOR’S NOTE: My colleague, Jack Crooks tells his subscribers exactly where to place their stop-losses on every single trade he recommends, so you don’t have to. I urge you to check out his service here.

Sean Hyman, “Professor FX” and Long-Time Currency Analyst Explaining How You Can Succeed in the Currency Markets.
Sean Hyman spends his days teaching his fellow professionals in the industry how to trade the $4 TRILLION currency market. Now he brings his 15 years of financial experience to you. From long-term currency strategies, to quick FX-trading moves usually reserved for the professionals, Sean will tell you everything you need to know to succeed in the currency markets.