By Adinah Brown
Risk management is a critical attribute of a successful trader and is a skill that needs to sit at the crux of any investment. Yet, while there may be uniform agreement on this sentiment, there tends to be two schools of thought to approaching risk. On the one hand, it’s not worthwhile to risk a significant amount of money for only a small return, but on the other hand, while a leveraged trade does have a powerful potential for profit, it also has an equally strong potential for loss. Not infrequently have there been traders who have traded really well, to the extent of holding 90% profitable positions, only to see it all become undone because they have not had a resolute risk management strategy in place. The solution lies somewhere in the middle; placing trades with a strong capacity for turning into a substantial profit and at the same time ensuring that the risk of those trades are managed well. In this article we present you with some of our preferred methods of managing risk.
1.Be Risk Conscious
Risk is a constant to every trade. What you need to do is ensure that your balance of risk versus reward is stacked in the reward category. For example, there is limited value in risking $1,000 to make $5, particularly if the chances of success are very small. The greater temptation is to risk $1,000 to make $50,000, but the probability of succeeding is so small as to make it an unacceptable risk. Before every trade you need to calculate what the potential loss may be and how you can mitigate that loss by putting in defined risk strategies, such as a stop loss and a take profit margin. This ensures that you are not making unmanageable risky trades and at the same time, it maximizes your chance of success.
2.Practice makes Perfect
Understanding when to leverage or place a margin call is necessary for new traders to get used to the practical aspects of risk in trading. The situation is never straight forward, on the contrary, weighing up the risk always represents a tricky dilemma. A good solution to developing skill in these practical risk management elements is to get a demo account. Without any of the emotional stress that comes into a real trade, a demo account will allow the novice trader to familiarize themselves with these risk management techniques and calmly know how to apply them as needed.
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3.Position yourself to succeed
This is done by aligning your risk and reward strategy with your precedent of trading success. Let’s say you are successful in picking the direction of the market 50% of the time. If you set your profit margin at 2 pips and your stop loss at 2 pips, then over time you will find that they will cancel each other out and you won’t have made any profit. But if you set your stop loss at 2 pips and your profit margin at 3 pips then over time you will make half a pip on average in profit on every trade. The lesson here, is that you need to analyze your trading behavior and work with that identified pattern to take the risk out of your trading.
4.Following in the footsteps of giants
Following the trading behavior of exceptionally successful traders via social or automated trading, can be a great way to develop a proven trading style. Find a successful trader on social trading or automated trading platforms and copy their trades. Even more so, you can document their strategy and pay attention to the position sizes that they take. Many social trading platforms also allow you to test your own skill at their strategy on a demo account. This method can be a great starting point for establishing your trading plan and risk strategy.
About the Author:
Adinah Brown is a professional writer who has worked in a wide range of industry settings, including corporate industry, government and non-government organizations. Within many of these positions, Adinah has provided skilled marketing and advertising services and is currently the Content Manager at Leverate.