Controlling FX Exposure

Risk control should be at the forefront of a traders mind at all times. Traders need to be continually aware of what their exposure is to any product at any time, just as a scuba diver is aware of how much air they have left in their tank. Traders without stringent risk control procedures in place, risk losing all of their trading capital. Too often we see traders come to us who are far too focused on how much they are going to make rather than how they are going to ensure they control their downside.

Where traders can get caught out is when they have multiple FX trades open at one time with exposure to the same currency. For example a trader may be long EURUSD and long AUDUSD at the same time. Usually this trader may only risk say 1% on any one trade, however this trader now finds themselves in two trades, both with 1% risk (2% net) which can be adversely affected by a strengthening US Dollar. Generally when there is a strong move in one currency, the effect is translated right across the pairs of that currency so your exposure level to any one currency must be carefully monitored.

A simple and effective way that traders can control their exposure to any one currency is to split their position size so the total exposure remains at 1%. So if you wanted to enter long into both EURUSD and AUDUSD instead of taking a full position on each, you would expose each position to only half a percent risk. From doing so, you have ensured that you've only got 1% of your total capital exposed to a strengthening US Dollar.  Many traders fail to realise how closely correlated FX pairs can be, especially if the moves are impacted by a news event. In that circumstance all USD crosses can display almost the exact same price action, so the fact that you are positioned in two different products (EURUSD and AUDUSD) which you would normally associate with diversification, now shows direct correlation.

Whenever you have more than one position open in your trading portfolio you need to be well aware of your risk limits and how each position relates to the next as the markets are full of correlations. Focus first and foremost on risk control and secondary to that comes profit. What you want to avoid in the markets is one move in a certain market having a negative influence on more than one of your open trades, resulting in you losing more than you wanted to from a single cause.

Happy Trading!  
 

The TWP Team