Risk Management in Forex Trading (For South African Traders)

Risk management is the practice of limiting or reducing risks associated with trading or investing in the financial markets. From a theoretical perspective, rewards are always associated with different levels of risks and when it comes to trading, it’s no different. It’s one of the most important aspects of a trader’s journey and could make or break any investor out there.

Traders can consider various factors to ensure that the risks involved in certain trades are justified and not overwhelming.

Major elements of proper risk management in Forex

There are several important elements to proper risk management for all forex types and keeping them in mind will help traders navigate the highly dynamic but sometimes treacherous financial markets.

Risk appetite

When it comes to risk appetite, it starts with the person and their tolerance towards losses. Some people are more aggressive, willing to lose a lot if they truly believe in a specific opportunity, if they also win big on other trades that do work out. Others may be more on the conservative side, settling for smaller potential losses in return for smaller potential profits. 

A good rule of thumb is to risk between 1-5% of your account balance per trade. Even at 5%, this gives you a fighting chance if many consecutive losses take place and you’ve had a bad run in the markets.

Position size

In line with your risk appetite and what you are willing to lose per trade, the position size is determined according to the mentioned criteria. If you have a small account but looking to risk 5% per trade would define a position size that is larger than a risk tolerance of 1% per trade. It’s all relative to what you aim to achieve in the markets in terms of risk and reward.

Stop loss

A stop-loss is a predetermined price level where you decide to exit a trade to limit losses. When set, the trade automatically closes upon reaching this level. The stop-loss is typically determined based on factors such as position size and risk tolerance per trade.

Beyond limiting losses, a stop-loss also helps protect against sudden and unpredictable market movements that may not necessarily invalidate your trading strategy but could create temporary volatility. If your stop-loss is triggered, it’s essential to assess whether your strategy can adapt and improve from the experience.

Stop-loss levels should align with your expected market rewards. Let's say for instance, if you set a stop-loss at 100 points and anticipate a 300-point profit, your risk-to-reward ratio is favorable, providing both growth potential and protection against future losses. A single 300-point win can offset losses from three unsuccessful trades of 100 points each.

Traders should aim for a risk-to-reward ratio of at least 1:2 or higher whenever possible. The better your ratio, the more flexibility you have in handling losses while maintaining profitability.

For instance, if you target 400 points per trade while risking only 100 points, you would only need a 30% win rate (three wins out of ten trades) to secure a 500-point net profit. Although achieving such a high ratio consistently is challenging, a more practical target might be a 1.5:1 or 2:1 risk-to-reward ratio.

It's also worth noting that traders with a high win rate can afford to use a smaller risk-to-reward ratio. If a trader wins six out of ten trades, they could work with a 1:1 ratio, meaning potential profits and losses are equal. In this scenario, the trader remains profitable, as smaller but more frequent gains can be easier to achieve than larger, less frequent ones.

Leverage

Leverage is a crucial part of forex trading. While higher leverage doesn’t inherently increase risk, its accessibility and allure can lead to significant losses—especially for traders attempting to recover from a losing curve by placing overly leveraged trades.

Traders who utilize lower leverage tend to be more consistently profitable compared to those who use high leverage. By the end of the day, only a certain amount of leverage is necessary to open positions that align with your profit goals without exposing yourself to extra risk. Experienced traders focus more on percentage returns rather than absolute monetary gains.

Emotions

Emotions play a vital role in trading, making it essential for traders to stay neutral toward both gains and losses. Getting overly excited about profits or overly distressed about losses can be detrimental. Trading is a business, and losses are an inevitable part of the process—they should be accepted and managed strategically.

Sometimes traders may open positions out of boredom or revenge to losses they have accrued trading the markets. This should be avoided at all costs. The more mechanical a trader is the better odds they have in making profits trading the markets.

While no trader is entirely free from emotions, learning to control emotions effectively is an asset in itself. Even slight improvements in emotional control can provide a competitive edge, helping traders maintain consistency and  achieve success in the markets.

Be wary of the news 

In addition to choosing financial products that align with your forex trading strategy and risk tolerance, it’s crucial to stay aware of upcoming economic releases. While some news events are unexpected, scheduled announcements should be carefully considered, as they can significantly impact your open positions.

To manage risk effectively, you may want to adjust your stop-loss levels around key releases or partially exit positions to safeguard against potential price swings that could move against your initial trade direction.

Finding the right market

Not all trading products are equal. For example, bitcoin, seen in Figure 1, and other CFD cryptocurrencies can be highly volatile, exhibiting moves more than 30% in a day. Others may not be so fast-moving and tend to move in a more orderly manner. Finding the right instrument for you means creating stability throughout your trading journey. 

Figure 1

There is not a clear formula for this. Someone looking for small moves to trade using high leverage may find a more peaceful approach with low volatility instruments while someone with the same characteristics could enjoy the rawness and speed of a highly volatile instrument which could give him a similar outcome in a short period of time.

A conservative but long-term trader may choose a highly volatile instrument if they plan to hold smaller positions with bigger stop losses. Effectively, they do not care about the volatility and are more concerned with the long-term outcome of a specific instrument.

What’s the safest leverage ratio for South African Forex traders 

The safest leverage ratio depends on the trader’s risk tolerance and trading goals regardless of their location. Higher leverage is a double-edged sword, that gives traders a chance to capitalize on the positions, but it also carries higher risk of significant losses.  

As we mentioned earlier, Choice of leverage varies from trader to trader as it depends on their goals and experience.  For those who are beginners or have lower risk tolerance, lower leverage ratio ranging from 1:10 to 1:20 is the better choice. On the other hand, seasoned traders having higher risk tolerance usually go higher up to 1:100 leverage ratio. 

Are there specific currency pairs that carry higher risks in the South African market? 

Currency pairs carrying higher risks are volatile and more sensitive to economic uncertainty. In South African market, forex pairs including South African Rand are most volatile because they tend to be more sensitive to the economic and political shifts in South Africa.  ZAR/USD and ZAR/EUR are high risk currency pairs in South Africa as they are most influenced by the local ecopolitical and social conditions in the region.