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Risk Management in Financial Markets


In finance terms, risk means you never know whether you will be laughing all the way to the bank or watch your cash go down the drain. Every investment has an element of risk to it. Even if you are the prudent type, keeping all your money in a bank and steering clear of the rough and tumble of the markets, you might still have inflation chipping away at your savings. As bad as it may sound, risk is also a quantifiable opportunity. A perspicacious trader, capable of weighing risks and seeing through opportunities, can make a lot of money.

If you want to make money on Forex, there are three concepts you should know inside out. Risk, money and time management. This trio unlocks the door to getting good returns on investments. You must get the hang of these three concepts as a trader to make informed decisions about your cash and remain in the black.

This new series of our finance articles turns the spotlight on risk management in financial markets. Check out our previous articles about financial markets if you want to learn more.


Managing your risk while trading on Forex and CFDs


Globally, financial markets are under inflation pressure. And it does not take a crystal ball to see that the USA, Germany and particularly developing countries won’t have an easy time of it at all with inflation in 2022. Investors will be looking for ways to hedge their savings against rising inflation. People are always drawn to financial markets to make profits on the back of smart investment decisions. 2022 will also see certain financial instruments take the centre stage.

Investors these days seems to have more appetite for risky financial instruments such as forex, stocks and cryptocurrencies. The bullish trend of the cryptocurrency markets in 2020 delivered profitable dividends to all investors, big and small, acting as a reminder that there is money to be made there. While the bearish market trends emerging towards the end of 2021 and gaining even more traction in 2022 pushes spooked investors towards commodities such as gold, silver, platinum or global company stocks. In short, while we may have seen more investors in financial markets buoyed up by the latest wave of bullish trends, the pendulum can always swing to the other side depending upon the market trends.


What is Forex? Why are Forex Markets Risky?


Most budding investors must be wondering, is Forex safe, or is Forex risky turning the question in their heads. But, it should be noted that risk is more about investors than the markets. Although Forex is driven by foreign currency pairs, it offers a wealth of other investment options. This could be commodities such as gold, silver, copper, platinum, cotton, soybean, corn; global indices such as DAX40, S&P500, Dow Jones, and stocks of global companies (CFD) such as Tesla, Amazon, Pfizer, Google, Alibaba.

On Forex markets, there is a thing called ‘leverage trading’, which essentially means you can open positions much larger than your own capital. For instance, if you are spreading bet on NASDAQ with a leverage of 10:1, you may only have to deposit $100, to buy a trade with a value of $1,000. Once you have entered the trade, you receive the benefit of any price movement on the full $1,000, and the downside of it is that you will also have to stand any losses in full. This just goes to show how capricious forex markets can be. But also remember that the greater the risk, the greater the award. If you get it right on a few leveraged transactions, you can multiply your cash pretty quickly, what would not be possible with short-term trading on spot markets. As it is, while pursuing profits on their forex positions, big investors tend to open large leveraged positions to hedge their cash against investments in other instruments.


What is Risk Management for Financial Investments? How can you manage your risks?


Risk is defined in financial terms as the chance that an outcome or investment's actual gains will differ from an expected outcome or return.

Risk Management in Financial Markets involves;

  • Determining what portion of your assets you can commit to risky trading,
  • Knowing when to leave a position in a loss or win,
  • Implementing plans and strategies to manage the risks.

Risk management on Forex is the art of turning potential crises into opportunities. It is the process whereby you make yourself less prone to losses by correctly reading the market indicators.

One of the most important factors of risk management is trader’s psychology. Whoever sows sparingly reaps sparingly... While that is one truth an investor should always keep in mind, finance markets can turn into a losing game if you do not know the basics of trading analysis, merely playing it by the ear by acting on unfounded, speculative knowledge.

By not doing proper risk management, looking at the market from one perspective and focusing only on profit, you can suffer severe financial losses when price swings occur. To make sure that does not happen, you should know the markets, read them correctly and use smart approaches to stave off losses.

Every investor can suffer losses when trading on the stock markets. What matters is to manage the usual losses and risks. Limiting the loss or making profits is about correct risk management 50 or 60 percent of the time.

Risk management means minimising losses from price volatility or holding onto the profits made. Risk management is about determining and measuring the risk, forecasting how a particular risk may impact on financial gains, deciding whether it is worth taking the risk, choosing the correct risk management approach and time-planning.

Financial markets will throw your way endless opportunities along your money-making journey. And you can make serious cash if you do things the right way. Particularly if you can crack ‘leverage trading’ that offers a sea of opportunities. But, you must be equipped with the right sort of tools and have the right kind of training not to get drowned in it. Remember you can lose money as quickly as you win. Investors using the correct approaches always have the potential to make serious gains. You can always buy and sell assets using a demo account, to get an idea of how risk and money management works.

Leverage trading can bring you good profits in the short-run, while wiping out your entire earnings in a flash, making leverage trading a high-risk zone for investors.

Risk management is unique for each trader, taking shape depending on your budget and your profit-loss balance. The biggest challenge for an investor is not to get caught up in a frenzy of profit-making, and know where to stop. Closing at least some of your positions to do profit realization, you will at least take your break-even point to a new price level or lessen your likelihood of losing money.

As a trader, you won’t always have a smooth ride of it all, so be prepared to take losses. No investor always wins, getting ROI is never a given. So, always bear in mind that this is a tricky landscape that also involves losses. When trading, you should always read the signals coming from your chosen tool of instrument. To help you do so, you can follow the finance news, read the market analyses or listen to the experts.


A Few Tips to Help Investors Keep Their Risks Under Control


  • Do not put all your eggs into a single basket: diversifying your portfolio of investments to include risky and less risky tools can help you maintain a healthy level of profit and loss.
  • Finance markets might cut you some slack if you are a lucky person overall and you may find yourself making some easy wins. But luck can only take you so far. You will need more than luck if you want to fill your coffers on forex or the exchange markets. So, if you take flimsy, non-scientific advice for granted and go out on a limb, you will definitely shed some cash off your wallet. Signing up for a forex course from a reliable provider, which can either be free or a payable service, can help expand your finance literacy and pivot your position towards more lucrative investments.
  • For instance, it is always a good idea to set a stop/loss point each time before you trade. Placing a stop order for when your stock goes ten percent below the buying point can hedge you against further losses.
  • In order to limit or prevent loss, you can tailor your sell orders to your expectations from the market.
  • Keeping track of daily, weekly and periodic trends will help you read the market correctly, buy, and sell at the correct time.
  • Before dipping your feet in the world of investments, you can set up a demo account to hone your skills at trading using virtual money and without the risks involved.
  • By opening accounts in a trustworthy broker which are regulated by a financial authority, you can keep scammers at bay.
  • Try and see how parities react to global news about the economy, to help you make more informed decisions.
  • Risk management also involves trader’s psychology. Psychology management can help you hold the reins in, when you are too anxious because you have been losing money or you are puffed up with self-confidence due to a winning streak.