9 min read
The risk management approach that a trader is using can determine the whole outcome of a trading session. In this blog, we often emphasize that it is extremely important and traders have to think about it before entering the market. However, what exact steps could a trader take in order to develop an effective risk management strategy? There are 8 ways that might help manage losses and each step might get a trader a little closer to a mindful and more responsible trading method.
1. Choosing the capital management approach
There are two ways of handling one’s capital: the conservative approach for cautious traders and the slightly more aggressive approach for those with experience. No matter which one of them a trader chooses, the most important part is to stick to it no matter what.
The conservative method implies an investment of not more than 1% of the trader’s balance in one deal and using not more than 3% of the whole balance at once. This means, for instance, that a trader can only have up to 3 open deals at once and the total investment amount for all of them shouldn’t exceed 3% of the account’s balance. This method may be preferred by novice traders as it requires less funds for trading.
For example, if the total balance of a trader is $100, they can only trade with 3% of it at once – an amount of $3. They may open 3 deals of $1 investment each.
A more aggressive method suggests investing up to 5% in a deal and utilizing not more than 15% of the balance at once. This may allow a trader to open 3 deals, for example, with a 5% investment at a time. This method may be used by more experienced traders who know their preferred trading strategies and assets. With that said, traders have to diversify their risks so that their potential losses wouldn’t exceed 5%.
2. Asset diversification
Choosing just one or two assets and only trading on those can be quite risky: the market can be unpredictable and opening multiple deals on the same asset may cause unnecessary losses. Experienced traders choose at least 4-5 assets, preferably on different instruments (for instance, Stocks and Forex, Crypto and ETFs) that are available at different times, so that the trading conditions would differ slightly. Such diversification on a trader’s portfolio may allow them to manage the losses and risks that may occur.
3. Finding the right entry point
Though there is no way to be 100% sure about entering a deal, there are ways to determine better opportunities. They include utilizing technical indicators, following the news and relying on the received data rather than intuition. Entries should be executed with risk management in mind – protecting the initial capital might be easier than losing it and trying to earn a new one.
4. Trading long-term timeframes
Indicators are extremely helpful, however, they do not always give out perfect signals. They can be especially misleading on very short timeframes (unless specifically designed for short-term trading). That is why novice traders may want to stick to trading on a longer timeframe. Short-term trading is much riskier: traders often neglect the proper analysis tools and rely on their intuition, which sadly ends in losses. Aiming for the longer period allows to develop a strategy and analyze the asset better. Nevertheless, the trading periods used are always depending on the trader’s preferred methodologies.
The hedging technique comes in handy to those who are trying to manage risks. Hedging is opening a reverse position on the same asset in order to protect the capital in case the asset price goes in the wrong direction. For example, a trader may open “Buy” and “Sell” positions on the same asset in order to cover for a possible wrong prediction.
Hedging may help manage the losses, however it may also work against the trader by cutting their potential positive outcome. This method might be more suitable for experienced traders, as it requires some practice.
6. Trading limit
Experienced traders follow a number of rules when it comes to daily trading. One of the most important ones is setting the limit for the number of deals in a day, or a limit for the number of unsuccessful deals in a row. This limit can be a lifesaver when a trader is exhausted and starts giving into the emotions. An intermission between trading sessions is necessary to cope with the psychological factors that can really harm one’s trading. It may allow the trader to gather their thoughts, let go of the tension and mentally prepare for trading again later.
7. Analyzing mistakes
According to statistics, 95% of traders do not analyze their performance and don’t keep track of their deals. This means that they do not recognize their mistakes and, therefore, cannot fix them. Keeping track of all the investments, their results and the outcome is absolutely necessary for an effective trading approach. Otherwise the trader is doomed to repeat the same faulty pattern again and again.
8. Regular withdrawal of profits
Every week or month (whatever the trader feels comfortable with) it is important to withdraw a part of the outcome (30-50%) in order to feel accomplished and see the results. Even if the amounts are not very big, it will prevent the trader from getting discouraged and will help to focus on the important part of trading – generating an outcome.
These 8 tips are most effective when combined and utilized all together in a well-balanced strategy. A careful and mindful approach is important for those who wish to improve their trading routine and see results over time.