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Understanding of Risk Management Factor
Firstly, in simple terms, We are all very much aware of the term risk of the possibility of something terrible happening. The standard definition for risk is the impact of uncertainty on objectives that damage human value and bring undesirable consequences.
The methods used for evaluating, identifying, and controlling threats to maintain the organization’s capital and earnings are known as Risk Management. Understanding and assessing risk are different in every practice area from business, environment, finance, health, IT, safety to security and more.
If your trading account suffers from continuous losses in the Stock Market and you want to give up trading, then do not do it. We are here to help you by providing solutions to your problems to protect your account and get steady returns.
Getting emotional during trade and ending up with a losing side involves various reasons; however, the primary reason is poor risk management. Many traders fail to understand the importance of risk management and how it works.
Risk Management helps cut down losses and keep your earnings while trading in the stock market. If the risk factor can manage adequately, the traders can make money in the market and be successful in active trading.
Main Pillars of Trading
Trading System includes technical abilities like price action and chart reading using different techniques or indicators.
- Risk Management: Risk per trade, position-sizing, stop loss, target level planning come under this aspect.
- Trading Psychology: The mental aspect of trading is emotion control, and patience can lead to achieving your trading goals.
- These three aspects are interconnected, and missing one of them, the other two have no sense. The three parameters have important qualities for long-term investing or short-term trading.
Important Aspects of Risk Management
Suitable Broker: A broker who buys and sells shares on behalf of others. In the stock market, a broker is a firm that executes orders for investors for a commission. First, make sure the broker you choose is right for trading; some brokers can easily fool customers who trade infrequently.
Planning: Wearing a mask is essential in this pandemic situation that keeps everybody safe from viruses and pollution. Even if you take your vaccine jab, that doesn’t mean you are entirely secure from the Covid-19 virus. In the same way, taking the trade is risky without planning, and you will never know when you will get a loss. Therefore, it is essential to plan and take precautions before selling or buying the share, avoid real trading unless you have a detailed trading plan.
Capital Preservation: It is the most crucial task for successful trading. A good trader does not just have technical chart reading skills but can manage the risk of the capital with steady return without ending up on the losing side. It is a conservative investment strategy to preserve capital and prevent loss in a portfolio.
Stop-Loss (SL) & Take Profit (TP): The key points you can plan ahead are Stop Loss and Take Profit while trading. Successful traders know what price they are bidding to buy and asking for sell. They tend to measure the resulting returns over the probability of the stock hitting their goals.
On the Other Side, the unsuccessful traders or beginners enter a trade world without knowing the points at which profit or loss they will sell. Like gambling, based on luck and emotions begin their trades. They face the loss that often provokes them to make their money back, and people do over-trading and hold for a long time with the hope of gain.
One Percent Rule: The general thumb rule is you shouldn’t put more than 1% of your capital on trading into a single trade. The famous quote cut your dress according to your cloth is applicable in the 1% Rule. This one-per cent strategy is common for many traders, and some of them go for 2% of what they can afford.
For instance, if you have $10000 in your account, your position shouldn’t be more than $100 in any instrument. With higher value account balances, they may also choose the lower percentage, and it is the best way to keep the losses in check.
Calculate Expected Return: It gives a systematic way to estimate the profitable trade by comparing various trades. The probability of gain and loss can calculate using previous breakouts and breakdowns from support and resistance levels. This tool determines whether a trade has a positive or negative net outcome.
Diversify: Never put all your investment money in a single service or one stock; otherwise, you will get a huge loss. Remember to diversify your investments across sectors like industry, finance, metal, IT and more. It doesn’t only help to overcome the risk but also provides more opportunities.
Hedge: Another risk reduction strategy is the hedge; it is useful when an asset has an adverse price movement. The hedging policy is a way to get portfolio protection and be employed to offset losses in investment by taking an opposite position in the relative asset. However, hedging provides risk reduction, also results in a reduction in potential profits. It is typically involved in derivatives like F&O services.
Downside Put Options: For options trading, a downside put option is the most suitable one, also known as a protective put. It gives you the right, no obligation to sell the underlying stock at specified before its expiration time. Investors can use this strategy to protect the loss of owning a stock or asset.
How To Use Risk Managing Schemes in Trading?
Capital Preservation: The primary reason behind blow out trading accounts is the excessive use of leverage. It is necessary primarily for short term investment to prevent loss in a portfolio.
Risk To Reward Ratio: The Ratio of the total risk of the capital to potential reward on a single trade. The risk-reward ratio value is less than one doesn’t make any difference, and no need to consider this opportunity. Always look at the trade with a risk-reward ratio greater than one. Use it for comparing the expected returns of an investment with the amount of risk.
Set-Up The Stop Loss: The placement of SL (Stop-Loss) key factor assists the user in controlling the risk. All types of investing can benefit from this tool to prevent excessive losses and lock in profits.
Position Sizing: refers to the number of the lots or contracts you invest in a particular security in single trading. The combined information of SL, Entry Point and Position Size determines the amount of money you risk at once.
Set-Up The Targets: Logically arrange the target level; multiple methods are used to place the target, such as previous support and resistance and daily market price range. Set the target level before losing the better opportunity by controlling your fear of failing trade.
Trader’s Psychology: Psychology Risk Management is more important than the trading system. Don’t get attached emotionally to the position; cut the losses at predetermined levels and follow the trading plan.
Bottom Line
Generally, an amateur trader enters the market with the mindset of making tons of money rather than focusing on technical analysis, planning, risk management and capital preservation that lead towards losing the assets.
Instead, traders should know the right time to enter or exit a trade before participating in it. With the help of setting stop-loss effectively, a trader, either a newbie or pro, can reduce losses. Hence, plan your trade ahead of time to achieve the set target.