The forex market is actually not as dangerous as you like to think. Here are some strategies to minimize currency risk that you can try.
Since the beginning, forex trading is a very risky activity. First, the price direction is quite unpredictable. Second, there are so many things that can impact the price movement. The nature of currency will be driven by many supporting aspects such as supply and demand, interest rate differentials, economic growth, inflation reports, geopolitical developments, and many other factors.
For those who are dealing with the currency transactions such as retail forex traders, it is highly recommended to understand how the market works and what fundamental aspects play the biggest part. When you have learned about the forex market, you will get that there are actually a number of ways to minimize currency risks. The following strategies are the most popular ones that have been used by the majority of forex traders.
1. Analyze the Fundamental Side
A currency can be said to be a good currency if it has a good fundamental value as well. What is fundamental for currency? Generally, it reflects the aspects of the economic condition of a country. Everything that's going on in a certain country will impact the value of the currency.
Professional traders will trade on currencies based on the fundamental analysis. They analyze currency movements based on economic data and the political conditions of a country. Monetary policies and other economic indicators, like inflation rate, GDP growth, manufacturing index, and the unemployment rate are also included in their data lists.
Important news releases can drive market sentiment and increase currency risk. It will be encouraging people to buy or sell massively. In turn, these buying and selling actions can prompt a significant increase or decrease in the value of a currency, and affect the flow of investment into a country.
Thus, for a newbie who wants to learn to minimize currency risk, it is recommended to learn the basics of fundamentals analysis.
2. Apply Technical Analysis
According to technical analysis theory, the market always moves in a predictable range or at least has a certain pattern. Usually, the market moves in one of the three trends: uptrend, downtrend, or sideways. It happens because there is a repetition of the past that tends to happen again in the future.
In other words, using technical analysis is one of the best ways to minimize currency risk. Technical analysis will greatly assist traders in predicting where the market will move based on data from the past. To sharpen the analysis, traders will use technical tools and indicators.
A good technical analysis is usually set up with the following matters:
- Major support and resistance levels
- Trend indicators like moving averages and trend lines, to identify trends and judge the price strength
- Reversal of trends
- Chart patterns and what they mean
3. Have a Good Risk Management
Another way to minimize currency risk is by implementing good risk management. Without it, your account would suffer from unpredictable losses. To avoid such incidents, you can take advantage of the built-in features of the MT4 or MT5 like Stop Loss, Take Profit, and Trailing Stop.
Trailing Stop is a feature that many brokers offer to further complete traders' risk management. It is very helpful in adjusting Stop Loss and Take Profit levels more systematically and automatically while the position is still running. The distance between SL and the current price can be determined in a matter of pips, such as 15 pips, 20 pips, 30 pips, and so on.
But, keep in mind that Trailing Stops are most effective when applied in a trending market, i.e. when the price moves up or down consistently. In a sideways or ranging market, this feature is not recommended because your position would hit the Stop Loss before accumulating significant profits.
4. Utilize Hedging
The most common strategy used by professional traders to minimize currency risk is the hedging technique. The main purpose is to protect their trading funds from unfavorable price movements. They could either open Buy and Sell positions on the same asset at the same time, or on different assets with positive correlations.
If you are new to hedging, you can practice it in a simple way. This method is called direct hedging, which is opening position Buy and Sell on a currency pair:
Open Buy on EUR/USD at the price of 1.3000. If the price falls, open a Sell position at the price of 1.2800 in order to minimize losses from the previous position.
If the price movement continues to decline, then you can close the Buy position with a Loss result and leave the Sell position open which is likely to gain a larger profit. However, if you are not sure which direction the price will move, you can leave both positions open until a more definite signal appears.
In theory, hedging strategy does look very easy and profitable. However, in real market conditions, this technique can be quite tricky. Sometimes, the correlation between currency pairs change, and other times, the price simply makes it hard for you to determine where to open "the hedge".
5. Avoid Overtrading As Best As You Can
Avoid entering the market when the profit target has been met. Most of the time, risks come from the traders' inability to stay put. Too many entries in the market will have a negative impact on psychology, which usually leads to overtrading.
Overtrading can be categorized as a trading psychology disorder that makes traders open too many positions. Usually, it is caused by either greed or a sense of revenge. When they see that the price is moving in their favor, greedy traders often add positions or increase the size of the trade even though it's not in their trading plans.
On the other hand, the desire for revenge can also trigger overtrading. This intention begins with some consecutive losses that traders are not ready to accept. They feel that it is unfair for them to lose the trades, so in order to gain back what they lost, they would repeatedly attempt to enter the market with the same failed setups that they use before, unconsciously exposing more of their funds to the unforgiving market.
So, it's better to always stay away from overtrading by following your trading plan faithfully, be patient to wait for the best opportunities, and stay realistic.
Currency movement is a reflection of the economic condition of a country. The price can be very volatile when there are fundamental changes related to the country. These extreme currency movements can be an opportunity for retail forex traders, but also a disaster if not analyzed carefully. Some of the strategies above could really help novice traders to minimize currency risk and avoid devastating losses.
It's not as difficult as you think, since you can start by learning how fundamental, technical, risk management, and hedging work, as well as making sure not to overtrade when things don't go your way.