The risk management approach taken by a trader can be the deciding factor in many cases as to the outcome of a trading session. In this article, we emphasize the importance of traders having a risks management strategy in place before they enter the market. That said we’ll go into the exact steps that should be taken by a trader to come up with an effective risk management strategy.
We will discuss 8 ways that will help any trader manage their losses. Each step will get traders a little bit closer to more mindful and hopefully responsible trading which minimizes loses.
1. The Tried and True Capital Management Approach
As a trader, there are two ways in which you can handle your capital. You can either choose the conservative approach for a more cautious trading strategy or a more aggressive approach which is generally reserved for traders with experience. Regardless of what strategy you choose, the important part is to make sure that you stick with it.
The conservative approach will mean using an investment which isn’t higher than 1% of your balance in a single deal, and probably not over 3% for the entire balance in a single go. For instance, you can only have three deals open at once, and the total investment across them shouldn’t exceed 3% of the total account balance. It is a method that’s often best for novice traders since they don’t require as much money to test the waters and get some small wins.
Another instance of this is that let’s say that your total balance is $100, you should only trade with around 3% at a time which is $3. So, you can only trade with a $1 investment for each asset or currency pair.
The more aggressive method will raise your investment cap to 5% in a single deal but not exceeding 15% of the total balance. So, a trader using this approach can open three deals, each with 5% of their total balance. The method is best used by more experienced and aggressive traders who understand what they are doing based on their experience. However, traders should always diversify their risks making sure that the losses they experience don’t exceed 5% at a time.
2. Asset diversification
The decision to choose either one or two assets only and stick with them can be risky. The market is unpredictable at best, and opening up multiple deals with the same two assets, for instance, can lead to unnecessary losses. Generally, an experienced trader will choose around 4-5 assets and mostly across different instruments, i.e. Forexf, Stocks, ETFs, Cryptos etc. Each type of asset is available at a different time, which means that there are different trading conditions. By diversifying, traders can manage loss more effectively while mitigating risks to a great extent.
3. Locating the right entry point
We agree! There is no way to be 100% sure when entering a deal that there was a better opportunity. In fact, there always are better opportunities. Generally, it includes utilizing technical indicators, relying on data received and following the news and not just a gut feeling. All trades or entries need to be executed by keeping risk management in mind, which will protect your capital and raise the odds of making a profit.
4. Holding Trades for long timeframes
While many traders rely on indicators, their signals aren’t perfect. They can also be slightly misleading often on extremely short timeframes. That’s why as a newbie trader you’ll want to trade on often longer timeframes. It goes without saying that short-term trading has many inherent risks involved, because traders will rely mainly on their intuition instead of hardcore analysis tools, and that leads to losses.
When you hold a trade for longer, it allows you to develop a more long-term strategy to analyze assets in-depth. That said the trading periods would heavily depend on the trader’s chosen methodologies.
Hedging is a technique that when leveraged, will help to mitigate and manage risks considerably. The goal of hedging is to open a reverse position for the same asset to protect your capital if the price of that asset goes up often in the wrong direction. One instance of this is that traders will often open both a “Buy” and “Sell” position for the same asset like a currency pair to cover the loss regardless of which direction the asset moves in.
While hedging will help to manage losses, if misused, it can work against a trader since it eliminates their potential to make a profit from the outcome. That’s why it is a technique best reserved for seasoned traders.
6. Trading limit
Seasoned traders often follow a handful of rules when trading every day. The most significant of these rules is to set a limit for how many deals they will enter into a day and limit unsuccessful deals for the day. Setting a limit is important since it prevents a trader from giving in to emotions when they are exhausted. Taking a break in between trading sessions is necessary to cope with all the psychological and mental stress associated with it. Plus, a break allows traders to gather their thoughts.
7. Analyzing mistakes
Statics sadly show that up to 95% of traders aren’t analyzing their performance and aren’t tracking their deals. That’s why they aren’t able to recognize any mistakes they may be making, and because there is no record of it, those issues can’t be addressed. We strongly advise that all investments and the outcome from them should be tracked for a practical approach to trading. If not, you will be doomed to repeat those mistakes.
8. Regular withdrawal of profits
It is important to withdraw part of the income either every week or every month, depending on what a trader is comfortable with doing. Usually, 30%-50% should suffice. Even if those amounts aren’t substantial, it prevents you from getting discouraged, and that helps you focus on trading.
Now, these are 8 of the most effective trading tips which, when combined with a solid strategy, will mean profits. You will always need to take a careful and well thought of approach to be a successful trader.
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