Risk management is essential for successful trading, but many inexperienced traders overlook it. Without a proper risk management strategy, you put yourself in danger of losing some or all your hard-earned money - even if just one or two trades do not go your way.Trading is a high-risk activity: any time you enter a trade, you are risking your money, and if the risk wins, you lose that money. Trading risk management helps you limit your losses, and helps protect you from losing all of your trading capital.
Risk Management Techniques
1.Plan the Trade and Set Take-Profit and Stop-Loss Points Appropriately
Wars are won not on the battlefields but in the strategy room. Planning effectively will mean the difference between failure and success before you even enter the financial markets. Losing traders do not take the time to determine the points at which they are willing to sell either at a profit or a loss. To be a successful trader, determine the points at which you are willing to buy and the price at which you are willing to sell, in terms of both profit and loss.Rising prices can tempt you to keep holding on to your positions in the hope of increased profits, while falling prices can make you hold on in the hopes of recovering your losses. Setting a clear point at which to buy or sell can help you avoid these emotional pitfalls which often lead to losses.Take-profit (T/P) and stop-loss (S/L) orders are widely used as trading risk management techniques. The point at which you are willing to sell a stock and take the profit on your trade position is called a take-profit point. This is when there is a limited upside on the trade compared to the risk.For example, let us say that there has been a large move upward, and the price is nearing a key resistance level. You may want to sell before the price reaches a period of consolidation and set your take-profit appropriately.On the other hand, a stop-loss is a point at which you are willing to sell a trade asset at a loss when price action does not move in your favour. These points help you limit further losses on your trade position by cutting them earlier before they escalate.For example, if price breaks below a key support level, you may want to sell by setting your stop-loss point slightly below support to nip the losses in the bud. You can use both trend lines and moving averages to determine key support and resistance levels based on past price action, so that you can determine the best points to place your stop-loss or take-profit either below and/or above support and resistance.
2.Embrace the 1% rule
The 1% rule is a rule of thumb which many successful traders follow. This rule advises that you should never put more than 1% of your trading capital into a single trade position. Say, for example, you have $1000 capital in your account: you should not put more than 1%, or $10, in your position in any given asset you are trading. If your trading account balance is less than $100,000, the 1% rule is a good guideline, though some traders with large balances can afford to go up to 2%.Remember: as your account balance dwindles, so does your position in the market. So, the best way to keep losses at bay is to stick with a risk below 2% so that you do not lose a huge amount of your trading account on one or two trading deals that go badly.
3.Diversify Your Portfolio
Another trading risk management technique is diversification. This is where the saying “don’t put all your eggs in one basket” rings true. It is foolhardy to put all your trading capital in one instrument or stock - you are setting yourself up for big losses and failure.It is more prudent to diversify your trading across different market capitalisation, geographic regions, and industry sectors. Trade stocks from both small caps, mediums caps, and blue-chip companies, and make sure that these companies are spread across the globe and across different sectors of the economy. That way, you will be able to mitigate losses if stocks from a sector or region are not doing well in the market by holding on to other trade positions you have taken in other industry sectors.
4.Calculate the Expected Return from The Deal
The expected return is the amount you expect to gain if all goes well, aswell as the amount you expect to lose if the trade turns against you.Calculating your possible loss or gain from a trading deal is an important technique. It helps you to rationalise your trade by forcing you to think through them carefully and enables you to compare different trades systematically and select the ones with high profitability potential.It is important to ensure that you are ready to live with the results of your trade, and calculating the possible outcome prepares you for that. If you would be unable to cope with the potential loss, do not take the risk.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when trading in CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
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