Risk management must always form part of your core trading strategy – whether you are a professional or amateur online trader. Protecting the money you make is the sure way to make a consistent profit and secure a long, successful trading career.
Risk is a critical prerequisite to successful online trading. Besides, without a risk management strategy, traders who generate substantial profits over months can lose it all in one or two bad trades. Also, using indicators alone to make a profit can only get you so far, especially if you fail to protect your positions.
So how do traders develop the best techniques to curb and mitigate the risks of the market? This article discusses six strategies you can use to protect your trading capital and profits.
1. Use the One-Percent Rule
Capital protection should be the priority of any trader, hence the use of the one-percent rule. It requires you not to risk over one percent of your trading capital in one trade. The conservative rule ensures that you never risk more money than necessary in one trade.
2. Formulate a Trading Plan
Before you start trading, you need to have a trading plan with a suitable risk-reward ratio (R: R). It’s a strategy to follow while entering or exiting a trade, and you should always research it thoroughly to ensure consistency and longevity. Always define trading parameters, money management, and entry-exit points.
3. Stop-Loss and Take-Profit
Stop-loss is a limit you set at a particular price point to cut your losses and close your position when a trade goes against your expectations. Take profit is when a trade favors you. Always predefine your stop-loss and take profit before placing any trade.
4. Position Sizing
It’s the size of a particular stock that you are trading. Position sizing is essential in managing risk. It helps if you base every stock position you take on a criterion that depends on your trading capital and the risk you take in each trade. The formula to use to find your ideal position is as follows:
- Position Size = Risk Amount/ Stop Loss
The formula helps you manage and execute your trades.
5. Portfolio Diversification
Never put all your money in one instrument or stock. Instead, diversify your investments across market capitalization, industry sector, and geographic region. Apart from helping you manage risk, it also opens your investment opportunities.
Hedging refers to a risk management strategy that allows you to avoid potential losses in risky situations. It enables you to create another trading position that protects (hedges) your current stock position against unknown market movements and risky scenarios. Hedging minimizes your risk of losing money and mitigates market volatility. It also involves derivatives like futures and options contracts.
The Bottom Line
There is no clear answer to how to avoid trading risk definitively, but using one or more of the strategies above can help you better manage and mitigate it. You could also turn to software solutions, such as the Aryatrading trading website, and use an online trading community’s collective intelligence to automate your risk management.