Traders often perceive risk as a one-dimensional beast but it has two horns…
When we talk about risk in trading what comes to mind? Most traders will immediately think along the lines of how much of their money is at risk on any one particular trade.
The other kind of risk for the forex trader is how much money you have exposed to the entire market at any one time.
For example, if you risk $1000 on a trade in a $10,000 account, the nominal risk on the actual trade is $1000. In reality, due to the fact that the broker could go bust at any time or some other disaster occur, your risk is actually $10,000 – the entire amount of the account.
There is also another element to the concept of risk that you as a trader may not be aware of or may not consider on a day-to-day basis.
This relates to the way your total trading account is spread across different brokers’ accounts.
If you just put all of your money into the one forex trading account with a single broker based on the research you have done into which forex broker is the best fit for you, it can be easy to forget the fact that the total risk you are taking on a moment by moment basis in that account is the entire amount of the account itself.
This is because the brokerage can go bust, cease trading, have their licence to trade frozen by a regulatory authority etc etc etc. This has happened several times over the years with usually disastrous consequences for those who have “put all their eggs in the one basket” i.e. put all their money with that one broker. This is in effect a Black Swan risk for traders.
Also remember that in this situation you don’t even have to put on a trade to be at risk. It is something that each and every one of us should be aware of at all times.
So, obviously it’s best to spread your account across several brokerage firms. This may be a little inconvenient depending on your style of trading and level of comfort with the idea of managing more than one account at the same time. However, it is extremely important to do this if you are putting a lot of money into the market.
A third consideration relates to the amount of money you actually have to trade with. Let me explain by asking a question: what is the maximum amount of money that you could afford to lose in trading, in total? If you say have $100,000 in savings but you are only prepared to lose $20,000 before you give up trading as a bad joke, then obviously the answer is $20,000.
So in the first risk model you would open a single account with $20,000 in it; in the second risk model you might open two different brokerage accounts with $10,000 each in them. In the second risk model you have halved your total broker risk at any one time.
But there is a further way to fine tune this.
The answer is don’t put all of your $20,000 into brokers accounts, and simply leverage up your individual trades to give the effect of trading on a $20,000 account.
So let’s say we only put $5000 into each of two accounts. Now our total broker risk at any one time is $5000, half of what it was in the improved second risk model to begin with.
Of course, in order to achieve the same profit potential you would have to be effectively doubling your risk per trade from what you would have done in the first scenario.
All of this needs to be taken into account as you build your risk management model, but it is important to remember that any money you have in the market is permanently at risk of being wiped out at any time…
So, there are strategies for withholding a certain amount of your trading account in a “buffer account” outside the marketplace, for example in a bank account. Not that even those are 100% risk free of course, but that’s another story…
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