Risk management aids in the reduction of losses. It can also help traders avoid losing their entire investment. When traders lose money, they are exposed to risk. Traders can open themselves up to generating money in the market if risk can be handled.
It’s a necessary but frequently neglected prerequisite for active trading success. After all, without a strong risk management technique, a trader who has made significant profits might lose it all in just one or two disastrous trades. So, how do you come up with the greatest methods for reducing market risks?
This post will go through some basic tactics for protecting your trading winnings.
1st: Plan your Trades
Every battle is won before it is fought.Chinese military general Sun Tzu’s
This expression says that wars are won by planning rather than combat. Successful traders often use the phrase “plan the trade and trade the plan,” as well. Planning ahead, just like in combat, might spell the difference between success and defeat.
To begin, ensure that your broker is suitable for frequent trading. Customers who trade infrequently are catered to by some brokers. They demand excessive charges and don’t provide active traders with the necessary analytical tools.
Stop-loss (S/L) and take-profit (T/P) points are two important techniques for traders to plan ahead when they trade. Successful traders know how much they are willing to spend for something and how much they are willing to sell it for. They can then compare the resulting returns to the likelihood of the stock meeting their objectives. They execute the trade if the adjusted return is high enough.
Unsuccessful traders, on the other hand, frequently initiate a trade with no understanding of the points at which they would sell for a profit or a loss. Emotions begin to take control and determine their trades, similar to gamblers on a lucky—or unlucky—streak. People generally cling on to their losses in the hopes of recouping their losses, whilst wins can tempt traders to hold on for even more gains.
The One-Percent Rule
The one-percent rule is followed by a number of day traders. This rule of thumb basically states that you should never invest more than 1% of your capital or trading account in a single trade. So, if you have $10,000 in your trading account, you shouldn’t have more than $100 in any single instrument.
This is a frequent technique for traders with accounts under $100,000—some even go as high as 2% if they can afford it. Many traders with larger account balances may prefer to use a lesser percentage. This is due to the fact that when the size of your account grows, so does the position. The easiest method to limit your losses is to keep the rule around 2%—any higher than that, and you’ll be losing a significant portion of your trading account.
Stop Loss and Take Profit Points
The price at which a trader will sell a stock and accept a loss on the trade is known as the stop-loss point. When a trade does not go as planned, this is a common occurrence. The points are intended to avoid the “it’ll come back” mentality and to keep losses from spiraling out of control. When a stock falls below a crucial support level, for example, traders frequently sell as soon as feasible.
A take-profit point, on the other hand, is the price at which a trader will sell a stock and benefit from the transaction. When the additional potential is limited by the hazards, this is the case. For instance, if a stock is approaching a significant resistance level following a large upward move, traders may wish to sell before a period of consolidation occurs.
How to Set Stop-Loss Points More Effectively
Technical analysis is commonly used to set stop-loss and take-profit levels, but fundamental analysis can also help with timing. For example, if a trader is holding a stock ahead of earnings and anticipation grows, they may wish to sell before the news is released if expectations have risen too high, regardless of whether the take-profit price has been reached.
Moving averages are the most common method for determining these points because they are simple to compute and generally followed by the market. The 5-, 9-, 20-, 50-, 100-, and 200-day moving averages are all important moving averages. These are best determined by applying them to charts and assessing whether the price has reacted to them as a support or resistance level in the past.
For me, however, it is better to set the stop loss point differently, since the moving average lines do not often have much significance.
On support or resistance trend lines, you can put your stop-loss or take-profit levels. These can be drawn by linking prior highs or lows with large, above-average volume. The key, as with moving averages, is to figure out what levels the price reacts to the trend lines at, and on high volume, of course.
Calculating the predicted return also necessitates the establishment of stop-loss and take-profit points. This calculation’s significance cannot be emphasized, since it encourages traders to think through and rationalize their trades. It also allows them to compare different transactions in a methodical manner and select only the most successful ones.
The following formula can be used to compute this:
[(Probability of Gain) x (Take Profit % Gain)] + [(Probability of Loss) x (Stop-Loss % Loss)]
For the active trader, the result of this computation is a predicted return, which they would compare to other chances to select which stocks to trade. The chance of profit or loss can be determined using past breakouts and breakdowns from support and resistance levels, or by making an informed guess for experienced traders.
You can do this calculation on your own, but it takes a lot of time and effort. There are also many tools that help you perform calculations, such as the website: MyFXBook Forex Calculators
But since this is quite time consuming, we recommend to use a tool like Pipz! Here you have the possibility directly in Metatrader 5 to perform the calculations automatically!
Before entering or exiting a deal, traders should always know when they intend to do so. A trader can reduce not only losses but also the number of times a transaction is exited unnecessarily by efficiently implementing stop losses. Finally, organize your battle strategy ahead of time so you’ll know when you’ve won the war.