Risk Management – 6 Essential tips every trader should know
Take-profit, stop-loss, indexes, ETFs, risk-to-reward. Confusing right? Does it make you feel bored? Or stupid? I don’t blame you; trading firms love to use confusing terms to make you think that only they can do what they do. Today we are going to talk about risk management.
You can honestly have the best trading plan in the world, but without solid risk management in place, you can still take loses. As a trader, you need to understand how to manage your risk, size your positions and set your orders correctly if you want to become a profitable and professional trader.
As a trader, managing your risk is just as important as developing a solid trading strategy. No trader is perfect, and all traders will inevitably have losing trades or even losing streaks.
Managing risk is easy once you know the formula, today we are going to give you 6 simple tips to help you manage your risk straight of the bat.
1. Don’t trade more than you can afford to lose.
First things first. The number one thing that you can do to manage your risk like a pro is to never trade money that you can’t afford to lose. I know it can be difficult, but you need to not let your eyes be too big for your belly. Everyone wants to get rich quick, but if you go into this with this mindset, you are taking the wrong approach. You CAN make a lot of money trading, IF and only IF you follow the steps and the processes laid out.
If you are trading money you can’t afford to lose, such as using too much leverage, and you lose significantly or even face the threat of losing significantly, your decision making will be compromised, and mistakes will happen.
When I first started out, I got hit by this myself. It’s not fun, but it happens, every trader goes through this. I’m telling you to prevent you from going through this yourself.
2. Allocate time to calculating your risk on each trade.
You should be allocating time for every trade to calculate your risk. This may seem simple to the majority of traders rush this important aspect of analysis.
Take note that when I trade, I often pass up many possible trades that at first look great, but when I start calculating my risk it doesn’t seem to add up. The average beginner spends little to no time calculating and managing risk, before placing a trade.
Why is it important? Well, we are in the business of making money, and in order to make money, we have to learn how to manage risk and potential losses.
3. Risk to reward ratio
Life is a constant battle between risk vs reward. No matter what you do in life you have a reward and you have risk. The markets are no different. Trading is NOT gambling; this where a lot of people are wrong. The way you need to look at it is, you have how much you are willing to lose and how much you are willing to make.
This is where we are going to do a little bit of maths, don’t worry I’ll try to keep it as simple as possible.
Let’s say you do 10 trades.
And on EACH trade you have a ratio of 3 to 1. Meaning you make $3 when you’re right and you lose $1 when you’re wrong.
Out of those 10 trades, even if your right only 5 times (50%). Then you would make $15 for every $5 you lose.
4. Position sizing.
Many traders are just looking to get right into trading with little to no regard for their account size. They simply decide how much they can stomach to lose in a single trade and hit the “trade” button.
More times than not letting the last trade determine the size of the next trade, most likely doubling the size of a position due to making or losing money in a previous trade. meaning they have zero control of risk management.
This is the WORST thing you can do trading. If you are on a losing streak and you are doubling your position sizes. You WILL loose much than you should have.
This ties in with the next tip which is.
5. Don’t trade with emotions.
We all have this natural human nature called greed, which is constantly pushing against risk management, some of us experience it more than others. I myself have a high tolerance for risk, due to my experience and personality. But you need to ask yourself the question of how much you are willing to lose on a trade.
6. Learn from your mistakes.
It is ok to make mistakes, but not ok to repeat them. Many traders keep losing money, repeating the same mistakes and not learning.
A gambler doesn’t remember what they have done right to make money or what they did wrong to lose. If you remember what part of your strategy has made you money, you will do more of the right stuff and stop repeating the wrong moves.
Let’s be realistic: it’s difficult to remember all the nitty-gritty details of trading tools, systems, entries, exits, news reports, and all of the other complex details. That’s why we write these things down. Successful traders keep good records, review them, and learn from them.
The markets are constantly fluctuating and changing if you don’t adjust your trading strategy you cannot adjust with the markets. A trading strategy will work much more effectively in one market environment as opposed to another. I review my trading data to see how my strategy is performing in the current market to see how I can continuously adjust and improve to maximise my profits.
A fine-tuned risk management strategy is what gives traders the ability to lose on trades without causing irreparable damage to their accounts. Think of it this way. A day trader can have a 50% win rate and still be profitable if their average profit is twice the amount of their average loss.
If you want to learn more head over to starttrading.com blog. The easiest place to start trading.