Hello fellow traders!
Important topic for traders — risk tolerance in the Forex market. Risk tolerance — this is the acceptable level of loss of the trading system, which the trader deliberately takes, counting on the potential profit. Assessing your own risk tolerance is an important step in the development of a trader, as it allows you to determine the strategy that is right for you. The article also examines various factors that affect risk tolerance and gives recommendations on how to determine your own pain threshold for losses.
The first question that traders ask after studying the theory of the Forex market is the search for a strategy. Most beginners are interested in intraday trading, deposit overclocking, scalping on M1-M15 timeframes. However, trading theory recommends analyzing and building strategies on higher timeframes. They smooth out the noise of currency fluctuations and random microtrends that are present on minute and hourly candles.
Intraday trading is attractive because it gives you the opportunity to receive daily profits, but in practice, traders most often lose their deposit. Emotions, psychology and discipline are the first things that are mentioned as the reasons for losing an account.
In reality, the main reason lies in the trader’s tolerance for risk. Understanding your own loss tolerance allows beginners to avoid losing their deposit.
Risk tolerance can be the key to successful Forex trading for the professional trader as well. Changing the strategy to a less risky one can relieve a significant emotional burden, give more time for analysis and ultimately maximize profits.
What is a trader’s risk tolerance?
Risk tolerance is an acceptable overall level of loss of a trading system, which a trader consciously takes, counting on potential profit. The amount of account drawdown directly affects trading decisions and results.
Having chosen the “wrong” strategy, a trader with low tolerance will not be able to follow its rules with all efforts to maintain discipline. After a series of losing trades, orders will be closed with minimal profit, any temporary drawdown will make trading decisions doubtful, etc.
A risk-aware trader who has no doubts about the profit potential of the strategy or even knows about the inevitability of losing the deposit sometime during the trading process, withstands abnormal drawdowns.
In fact, this is a portrait of all those who trade using the Martingale system. Years of experience and tests carried out, as well as the choice of tools, give them a clear understanding of the “expected cons”. They perceive the growth of losses as a chance to increase the trading lot and get a higher profit on the rollback. On the other hand, an adequate user of the Martingale strategy understands that he can “catch” a long-term countertrend, which will lead to a drain on the deposit.
How to determine your own risk tolerance in the market Forex?
A trader must understand that there is no universal approach to determining acceptable risk, since this is a purely personal decision, which can also change for a number of different reasons. Tolerance is influenced by the level of finances, knowledge, personal circumstances, greed, greed, success and trading failures.
A long-term positive result can make a trader forget that strategies “merge” over time due to trend changes and volatility. Sometimes it is difficult to force yourself to optimize a once profitable algorithm, it is easier to believe that the current loss will soon be replaced by a profit, or vice versa. Large losses force the trader to trade with high risk in the hope of “recapturing” the deposit.
It is generally impossible for a beginner to understand his own “pain threshold” of losses. Of course, there are a lot of tests on the pages of the TradeLikeaPro website and other specialized resources that help in this matter. Links to them can be found at the end of the article.
However, there is a set of initial steps and general guidelines that will help in determining risk tolerance. Why should they be followed? In order not to lose the deposit, save yourself from unnecessary emotional experiences.
1. Assess your own financial situation
A trader must decide what income he expects to receive by trading on Forex. How much money can he spend on the first deposit? Will there be an additional attempt to make a deposit after the drain and how much? How will this affect your personal financial situation?
Thinking about a contingency plan and adding funds can increase your risk tolerance. This factor should be taken into account by the trader by reducing the initial investment amount.
The first deposit, as a rule, is completely lost by beginners, but they do not present risks of almost 100% probability of losses. Therefore, the very first deposit on Forex is always overpriced by & nbsp; size.
2. Determine in advance the amount of future earnings
How much profit does the trader expect from the invested deposit? If a trader expects to double and triple investments in a short period, then he cannot avoid big drawdowns.
Risk tolerance should always come first. A beginner should be prepared to lose half of the deposit in a short time. If losses lead to non-compliance with trading rules, it is better not to try to cultivate the discipline of transactions. You can simply moderate your appetite for expected earnings and focus on a conservative trading approach.
3. Pass the risk assessment test
Risk assessment tests will determine approximate risk tolerance. They typically ask questions about investment objectives, time horizon, and financial position to determine your level of risk tolerance. Honesty in your answers will help you avoid future losses and choose a trading system without deep emotional involvement in losses.
4. Start small
Regardless of the test results and the choice of strategy, a trader should not rush to make the entire planned deposit and choose large lots. The rush to earn money is a sign of greed, and this feeling in Forex always leads to poverty.
Invest a small percentage of savings set aside for currency speculation. Use a cent account if this amount is too small to trade.
The first results will prove or disprove the trader’s ideas about the profitability of the strategy. As positive transactions grow, gradually increase the deposit, but only after assessing the reaction to the resulting loss. So the trader will understand what percentage of drawdown does not affect the adoption of trading decisions, and what losses make mistakes, violate the rules of the strategy and lead to emotional discomfort.
5. Watch the results
It is important for a trader to understand, remember and evaluate the emotional reaction to losses and profits. You can even record it in the form of estimates on some relative scale in the diary of transactions. This will help to make a final informed decision about the acceptable level of risk.
By following these steps, a trader will more accurately determine their risk tolerance, make the necessary changes in money management, or even radically change their trading strategy, taking into account their individual emotional background, trading style, and financial goals.
How to consider the tolerance factor when choosing a strategy?
A trader will have to choose several types of strategies if he wants to take into account the factor of risk tolerance. In practice, forex traders choose only one trading system, which they then modify “for themselves”. The problem is that you cannot change the scalping strategy to a level of conservative trading with low risk.
To take into account the tolerance factor, a trader must:
- Determine the style of trading – trend/countertrend , breakout, impulse, news, martingale strategies, etc.;
- Select several trading systems working on different timeframes, giving preference to universal algorithms;
- Analyze the potential risks and rewards of each strategy based on available performance data and compare potential drawdowns with your own level of risk tolerance;
- Test the strategy and confirm its performance;
- Start live trading from a small deposit, constantly adjusting and analyzing losses, as well as their own emotional reaction.
Ideally, it is better to run several strategies, some of which will be more conservative than the chosen basic trading system. The trader will be forced to do this in order to keep track of several trading algorithms.
As a result, “natural selection” will occur: some trading system will merge, some will be uncomfortable for the user, and somewhere, on the contrary , profits will accumulate without much effort.
Understanding risk tolerance is the key to successful Forex trading. By evaluating your level of risk tolerance and developing a trading strategy that matches it, a trader will be able to fundamentally change his approach to Forex trading and maximize profits.
List of Tolerance Testing Resources to risk in the Forex market
What kind of trader are you
Van Tharp test
Do you have a chance to become a successful trader?
Vanguard Investor Questionnaire
FinaMetrica Risk Profiling
Forex Trader Risk Tolerance Test:
What is your main goal in trading ?
a. Achieve long-term capital growth — 2 points
b. Income — 1 point
c. Speculate and potentially profit from short-term market fluctuations — 3 points
How do you feel about losing money in the markets?
a. I am willing to accept some degree of risk in exchange for potential profit — 2 points
b. I’m comfortable with a moderate level of risk, but prefer to avoid significant losses — 1 point
c. I am risk averse and prefer investments with low risk and low potential for return — 0 points
How much market volatility can you tolerate?
a. I am comfortable with a high degree of market volatility and understand that it can lead to significant gains or losses — 3 points
b. I’m willing to put up with a moderate level of market volatility, but prefer to avoid extreme swings — 2 points
c. I prefer investments with minimal volatility and stable returns — 1 point
How important is it to you to beat the market?
a. It is very important for me to get a return that exceeds the market — 3 points
b. For me, this is somewhat important, but I am also satisfied with the average market return — 2 points
c. I don’t care how to beat the market, I prefer investments with constant and stable income — 1 point.
What is your trading time horizon?
a. I am a long-term investor and plan to hold my positions for several years or more — 2 points
b. I have a moderate time horizon and plan to hold my positions from a few months to a few years — 1 point
c. I am a short-term trader and plan to hold my positions for days or weeks — 3 points.
When you have completed the test and calculated your scores, you can determine your risk tolerance level as follows:
0-5 points: Risk averse
6-10 points: Moderate risk
11-15 points: High risk
A trader with no risk appetite may approach positional trading or trending strategies on the daily timeframe. A trader with a high level of risk should try intraday trading or scalping.