Nowadays, it’s relatively common for novice traders to think that making exuberant amounts of money online through trading is bread-and-butter. Nevertheless, successful trading is a lengthy process that requires time, commitment, dedication, and patience, if you want to be profitable and thrive in the long run.
After all, you can’t just open a trading position in the trading platform of your selection without taking into account the conditions set by your broker, the market, liquidity, leverage, and counterparty risks, that can significantly affect your capital. Or, in other words, novice traders shouldn’t immediately focus on making money but focus on protecting what they already have.
Well, in order to do that, as soon as you kickstart your trading adventure, you’ll need to apply specific techniques and strategies to manage your money and risks better. So here are the four common risk management strategies you need to implement right from the start because if you don’t, you wouldn’t be trading—you’d be gambling.
Diversify Your Portfolio And Hedge
To begin with, ensuring that you make the most out of your trading effectively means that you should never put all of your eggs in a single basket. In that context, if you, however, decide to put all your money in one stock, currency, or any other financial instrument, in all probability, you’re setting yourself up for a significant loss. Therefore, you should always try to diversify your financial instruments across market capitalization and the industry sector. This strategy will not only help you to manage your risks, but it will also help you open to more market opportunities.
Besides diversifying your portfolio, you will also find yourself in a position where you’ll have to hedge your trading position. Think about a stock position when the results are due, for example. Sometimes, you may need to take the opposite position by utilizing an options trading chart and help yourself protect your position in the long run. Then, when the trading activity subsides, you can unwind the hedge.
Always Set Stop-Loss And Take-Profit Points
If you’re a novice trader, you should get familiar with the stop-loss point, which is actually the price at which you will sell a stock, bond, option, currency, or any other financial asset and take a slight loss on the trade. This is the best-case scenario when a transaction will not pan out as you initially hoped. The stop-loss points are designed to hinder the “it will come back” mentality and limit huge potential losses before they escalate. For instance, if a particular stock breaks below a critical support level, traders usually sell immediately, which is what the stop-loss points will do for you automatically.
On the contrary, take-profit points are the prices at which you will sell the asset and take profit on the trade. You should always set take-profit points when the additional upside is limited, given the risks you might face. For instance, if a Forex currency is approaching a critical resistance level after a substantial move upward, you may want to sell before a consolidation period takes place.
Follow The 1% Rule Of Trading
Before you get your knees wet in trading, you should also familiarize yourself with the 1% trading rule. Fundamentally, this rule suggests that traders should never put more than 1% of their capital or trading account into a single trade. So, if you have $5,000 in your trading account, the 1% rule says that your trading position at any given moment shouldn’t be more than $50.
Novice traders usually utilize this strategy with less than $30,000 in their accounts, and many even decide to go as high as 2% if they can afford it, of course. But, on the contrary, many expert traders whose trading accounts have higher balances choose to go with a lower percentage. That’s because your account’s size enlarges, and so does your position in every trade. In that context, the best way to keep your prospective losses in check is always to keep the rule below 2% because any more and you’ll be risking a significant amount of your trading account.
Always Think About Your Risk Tolerance
Last but not least, before you dive deep into trading, it’s essential to determine your risk tolerance, depending on:
- Your age;
- Your experience;
- Your knowledge of trading;
- How much you’re willing to risk;
- Your personal investment goals.
Having a natural feeling about your risk tolerance is about getting a good night’s sleep and knowing that you’re in complete control of the situation. When you know that you’re trading the appropriate amount of money to your financial situation, then and only then can you have clear financial objectives for your trading. For that reason, always keep your trading within your risk tolerance framework and increase the likelihood of trading success.
In the end, these four pointers are just the cornerstone to better managing your trading risks, and as you’ll research further, you’ll find many other risk management strategies so you can improve your trading efforts. Whatever you do, always follow your trading plan, learn from your mistakes, and take responsibility for your losses.