How to Use Orders to Manage Risk in Forex

Forex trading allows people to profit from slight changes in currency exchange rates. However, forex trading can also go wrong quickly if too many trades move against you. That’s why experienced traders use orders to manage risk in forex. These orders limit your losses and allow you to exit positions with gains before they turn against you. This guide contains some forex trading orders you can use to minimize your losses.

Introduction to Risk Management in Trading

Every investment comes with risk, and knowing how to manage it can help your returns. Many traders use a mix of limit orders and market orders to time their entries and exits. Limit orders only go through when an asset reaches a specific price, while market orders go through at the current price.

Knowing the different types of orders is a great starting point, but you must also know your risk tolerance. Younger investors tend to have higher risk tolerances since they have more time to withstand market corrections and short-term losses. However, older investors who are approaching retirement usually get more defensive.

Knowing risk tolerance is important because it can influence the types of forex trades you enter. Approaching every trade knowing your risk tolerance can also help you set reasonable entry and exit prices for your positions. 

Effective Order Types to Manage Risk

Forex traders can use several types of orders to manage Forex trades. These are some of the top options that can help with mitigating risk.

Stop-Loss Orders

Stop-loss orders allow traders to limit the amount they lose on a single position. Investors can automatically exit a forex position if order flow moves against them.

You can set two types of stop-loss orders:

• Fixed stop-loss order: Traders can set a specific dollar amount when the position is automatically closed. For instance, if you buy a position at $1, you can set a fixed stop-loss at $0.90 to ensure that you only lose $0.10 for that position.
• Trailing stop-loss order: Traders can set a specific percentage loss that triggers an exit. For instance, if you buy a position at $1, you can set a trailing stop-loss at 5%. Then, the position automatically closes once the price reaches $0.95.

One of the main differences between fixed-stop loss orders and trailing stop-loss orders is that the exit price of a trailing stop-loss order can change. For instance, if a position valued at $1 turns into $1.20, a 5% drop now results in a $1.14 price point instead of $0.95.

As a position rises, the trigger price for a trailing stop-loss order also increases. This scenario doesn’t happen for fixed stop-loss orders, where you have to set a fixed price point for the trade to occur.

Limit Orders

Limit orders allow you to establish a price at which you will enter or exit a position. You instruct the brokerage firm to buy or sell at a specified price or better. For instance, if an asset is valued at $1.50 and you set a limit order to buy it at $1.45, it will only go through when it drops to $1.45 per share.

This type of limit order can reduce your downside when entering a position. However, you will miss out on those gains if the asset rises to $1.60 without touching $1.45. 

Limit orders designed to sell assets are similar. If an asset is valued at $1.50, you can set a limit order to sell it when it reaches $1.55. However, if it drops to $1.30, you incur the loss. The $1.55 limit order is still open, but it will likely remain open for a while.

These orders can prevent market participants from getting too greedy. Some trades become wildly profitable after a few days, only to turn into losses by the end of the week. Some assets are highly volatile, and it is better to lock in some gains than risk losing all of your progress.

Traders can open a buy limit order and a sell limit order simultaneously for any currency pair. Having both orders open can minimize your portfolio’s volatility and ensure that your gains and losses are within a predetermined range.

Some buy limit orders trigger below the set price, and it’s also possible for sell limit orders to take place below the price you intended. Order blocks can cause significant price movement that sharply increases or reduces an asset’s price. However, brokerage firms will try to trade the asset at your desired price. High liquidity makes a trade more likely to be executed at the limit price.

Take-Profit Orders

A take-profit order is a limit order that only goes through when an asset reaches a certain position. Traders use these orders to close their positions and take profits once the currency pair reaches a suitable level. 

For instance, if an asset trades at $1.50, you can set a take-profit order to exit the position once it reaches $1.55. This take-profit order can leave money on the table if it goes up to $1.60. However, it’s also possible for the asset to reach $1.55 before dropping down to $1.47. 

Investors should set take-profit orders based on their risk tolerance. Some traders need a minimum gain (i.e., +1%) to view a trade as successful. Even if the price increases, the trader can feel satisfied knowing they implemented a successful trade. 

Trailing Stops

Trailing stops allow you to set a minimum dollar amount that you want to lose from a trade. It’s similar to trailing stop-loss orders, except it’s based on a dollar amount instead of a percentage.

For instance, a trader can set a $0.20 max loss on a $2 position. That way, the position only gets sold if the asset reaches $1.80. However, if the asset jumps from $2 to $2.30, the trailing stop goes up to $2.10. 

These orders minimize your risk and reward the investor for any upside. If the underlying asset increases by more than the trailing stop amount, you can lock in a profit while potentially increasing your returns if the asset continues to increase.

Trading Forex While Minimizing Risk

You can’t eliminate risk from forex trading, but the order types discussed can mitigate risk. You can decide the optimal prices to enter and exit positions. These price points can help you lock in gains and minimize your losses.

Frequently Asked Questions