The risk management approach that traders take is incredibly important. So important that it can determine the entire outcome of a trading session. So we’re asking the question: what steps can one take to develop a strategy that’s effective and manages losses?
Lucky for you, we’ve come up with 8 risk management tips to consider when developing your strategy.
1. Choosing the capital management route
There are two ways to handle your capital. Firstly, there is the conservative approach for the more cautious traders and secondly, a more aggressive approached for the more experienced traders. Regardless of the method a trader may choose, the absolute key is to remain firm and stick to it.
The conservative method implies an investment of no more than 1% of the traders capital in one deal and avoid using more than 3% of their whole capital in one trade. For example, a trader can only have up to 3 open deals at once, but the total investment mustn’t exceed 3% of their account’s balance. This method is often preferred by novice traders as it requires less funds.
The more aggressive strategy suggests investing up to 5% in a deal and no more than 15% of their capital at once. This allows a trader to open 3 deals with 5% investment at the same time. Keep in mind that traders have to diversify their risks so that their potential losses won’t exceed 5%.
2. Asset diversification
Choosing one or two assets and trading on just those can be risky. The market is sometimes unpredictable and opening several deals on one asset could cause a trader to experience losses. A more experienced trader would choose at least 4 or 5 assets, preferably across different instruments (e.g. Stocks and Forex, Crypto and ETFs), which are available at different times, in order to vary the trading conditions. Diversifying a trader’s portfolio in this way may also allow them to manage their losses and risks more effectively.
3. Finding the right entry point
There’s no way to be 100% sure about entering a deal, but there are ways to decipher better opportunities. A trader might want to make use of technical indicators, keep up with relevant news or use data to determine an opportunity, rather than relying on intuition. All trades should be executed with these risk management tips in mind.
4. Trading long-term timeframes
Indicators can be extremely useful, but they don’t always give out perfect predictions. They can be particularly misleading during short timeframes, unless it’s specifically designed for short term trading, which is why the more novice trader may want to stick to using longer timeframes. Short term trading carries a high level of risk and traders may find that if they don’t use effective analysis tools and instead rely on their intuition, they will end up with losses. A longer trading period allows traders to develop a proper strategy and analyse the assets better.
5. Hedging
This technique is great for traders who are trying to manage their risks. Hedging is opening a reverse position on the same asset, to protect the capital in case the price goes in the wrong direction. E.g. a trader could open both Buy and Sell positions on the same asset, in order to cover all bases.
However, traders should be aware that this could also work against them by cutting their potential positive outcomes. It does require some practice, so traders must ensure that they know what they’re doing.
6. Trading limit
The more experienced trader will often follow a number of rules. The most important of these is to set a limit for the number of deals in a day, or to limit the amount of unsuccessful deals in a row. This rule can be a real lifesaver when a trader is tired. Breaks between trading sessions are necessary to refresh the mind. Trading when in a fragile state of mind could be harmful. It is good practice to have a break to gather your thoughts and return to trading later.
7. Analyzing mistakes
According to some statistics, up to 95% of traders don’t look back to analyse their performance and keep track of their deals. But if we can’t recognise mistakes, how can we fix them? Keeping track of all your investments, results and outcomes is an incredibly important way of developing an effective trading strategy. If we don’t, it will simply mean that the same mistakes are carried out again and again.
8. Regular withdrawal of profits
Whether a trader prefers to withdraw their profits weekly or monthly, it’s important to withdraw a part of the outcome (30 to 50%) in order to feel accomplished and to really see the results. Even if the amounts aren’t substantial, it can help motivate a trader and prevent them from feeling discouraged.
We hope that you find our tips useful and effective for your own trading strategy. A careful and considered approach will see a trader achieve better results over time.
