Risk management is one of the most important topics you will ever read about trading.As its name suggests, risk management is simply about managing your risk. Think of it as wearing a crash helmet when you are cycling, strapping your seat belt on when you are driving, or doing your warm-ups before starting a rigorous workout. We do these things in order to reduce the risks that we may face when carrying out these activities.
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 (potential losses). Ironically, this is one of the most overlooked areas in trading. Many traders are just anxious to get right into trading with no regard for their total account size.
They simply determine how much they can stomach to lose in a single trade and hit the “trade” button. There’s a term for this type of Trading….it’s called…GAMBLING! When you trade without risk management rules, you are in fact gambling.
Risk management rules will not only protect you, but they can make you very profitable in the long run. If you don’t believe us, and you think that “gambling” is the way to get rich, then consider this example:
People go to Las Vegas all the time to gamble their money in hopes of winning a big jackpot, and in fact, many people do win.
So how in the world are casinos still making money if many individuals are winning jackpots?
The answer is that while even though people win jackpots, in the long run, casinos are still profitable because they rake in more money from the people that don’t win. That is where the term “the house always wins” comes from.
The truth is that casinos are just very rich statisticians. They know that in the long run, they will be the ones making the money–not the gamblers.
Even if Joe Schmoe wins a $100,000 jackpot in a slot machine, the casinos know that there will be hundreds of other gamblers who WON’T win that jackpot and the money will go right back in their pockets.
This is a classic example of how statisticians make money over gamblers. Even though both lose money, the statistician, or casino in this case, knows how to control its losses. Essentially, this is how risk management works. If you learn how to control your losses, you will have a chance at being profitable.
Important risk management habits every trader should adopt.
1 Have A Stop-Loss On Every Trade : Stop-loss orders are the ultimate risk-limiting tools. (The exception is data/events where stop-loss order executions may be subject to substantial slippage. Avoid that risk by not carrying positions into news releases.) If you trade without stop-loss orders, you’re exposed to virtually unlimited risk.
2. Trade the Optimum Size Do not Leverage : Position size will ultimately determine your survival in trading— the larger the position, the greater the risk. Don’t be seduced by high leverage ratios and take too large a position. Trading too large a position relative to your available margin reduces your cushion against routine, adverse price movements. Keep your use of leverage to the minimum needed to trade your strategy.
3. Trade Well and With an Edge: Trading well means putting in the effort to do your own research, back-testing any new strategies you may want to employ, executing the strategies and keeping a close tab on your results.Be opportunistic, and spend your time and efforts looking for trading opportunities still to come instead of getting caught up in the market move of the moment. As a trader, you need to focus on being a good trader.
4. Keeping taking money out of Trading account :If you’ve made some money in the market, make periodic withdrawals from your trading account. We call it taking money off the table. If your profit stays in your margin account, it’s subject to future trading decisions, which represents an unknown risk. Keep your margin balance at a level that allows you to trade in sizes you’re comfortable with.
5. Understanding Yourself :There are many different types of traders. Some traders prefer day trading and may hold their positions from as little as a few minutes to a few hours. Others are swing traders who may hold on to their positions for days or even weeks, as long as the market is still trending in their favor. Trader as per your strategy and time frames.