Trading is an excellent opportunity to gain considerable amounts of profits. However, it also has high risks with the possibility of losing your investment with just a few bad trades. So, knowing about risk management in trading is critical to avoid too many losses.
Risk management is the process of identifying and evaluating dangers in trading. This is to apply available resources to control and minimize the occurrence of losses and maximize profit.
Here are some of the things you can do to manage the risks in trading.
Know How Much to Invest
Placing a reasonable trade size based on your available funds is necessary for choosing a risk management strategy. For example, you have $10,000 in your account, and you decide to deposit $9,500 to open a position. When there are a few movements in the market, your position can immediately close using all your available funds.
Instead, it’s better to use small amounts of your funds in depositing for leveraged accounts. If you have $10,000, choose a leverage account that you can finance with only about $1,800 to be open to more opportunities available. With this, you can also identify what to sell if there’s a massive loss.
Diversify Your Funds
Don’t put all your trading capital in a single market. Place your investments in several market trades to not lose your money all at once if the market goes low. For example, you can have trading accounts for cryptocurrencies, stocks, and Forex. If the price in the market falls or it closes, you still have many investments that you can take profit from.
You can practice the 1% to 2% rule of traders. Never put more than 1% or 2% in a single trade to ensure that you won’t lose all your capital. So, if you have $20,000 in your trading account, your position in any trade shouldn’t be more than $200.
Set a Stop-Loss
Stop-loss is a good way of preventing further losses for short-term traders. This order will automatically buy or sell a stock once it reaches a specific price.
If you don’t have a broker, there are several trading software that you can explore in setting up a stop-loss trading system. You need to set up the stop-loss point depending on your price loss limit. For example, setting a stop-loss order for 15% below the price you bought the stock means your loss will be limited to 15%.
Stop-loss is a good practice to avoid emotional attachments in trading. Most short-term traders are still hopeful that the market price will go back or become higher, so they lose even more.
Set a Take-Profit
Similar to the principle of stop-loss, take-profit sets a limit of the profit you can take. Setting a limit for profit gained may be ironic, but it’s done to prevent thinking that the price can still go much higher. Doing so will shield the trader from suffering a sudden fall in prices after continuous hikes, forfeiting the profits.
Understand the Risk-Reward Ratio
Putting a risk-reward ratio is crucial once you’ve set your stop-loss and take-profit points. Know that a 1:1 or even 1:2 ratio is not profitable. Any experienced trader will choose a 1:3 ratio where the reward is triple the expected risks. You need to know if the risks are worth the investment and the reward it promises.
Start Trading Slowly
Being familiar with the technical tools of software and how to use them in trading will aid you in knowing when to buy or sell your shares. Start with low trades like $30 to $50 or use bonuses with software you open your account with for practice. You’ll see the price movements and experience how the tools work firsthand, and learn to use them.
Once you understand how they work, trade with larger amounts. Your risk is now much lower because you know how to read charts and use the instruments in your software.
Try Backtesting Strategies
One good scheme to know current market performance is using a backtesting strategy with similar historical data. Use previous significant data in the market to know if your strategy will work. You can use statistical analysis of performance with Sharpe Ratio or Sortino Ratio.
It’s similar to a simulation where you use real data from old periods and simulate how your strategy will work if applied to it. Normally, using 2 to 3 years is enough for a holding period of 1 to 30 days. The longer the holding period, the more backtesting time needed.
If the analysis results meet a profit range, your strategy is good. If it doesn’t, adjust your strategy to achieve your goal earnings.
Trading comes with many risks, and managing them is vital. Take advantage of strategies and tools that can help you reduce losses. Don’t get carried away with emotions in dealing with losses and profits. Be smart, committed, and patient in buying and selling shares.