How Experienced Traders Mitigate Risk in Their Trades, and the Importance of the 1% Rule

FOREX Trading

Experienced traders have learnt the hard way that it is not always about maximizing gains in stocks and forex. Instead, effective risk management and the ability to minimize losses are just as important. Without mitigating risks, traders can lose all their money and their accounts before they have even started. 

The correct way to approach trading is to bake in risk management from the beginning. While winning streaks are nice and can generate huge profits, everything can quickly fall away if you don’t exercise restraint and make the right decisions when things are going against you. A risk management strategy will prevent losses from getting out of control and give you a platform to succeed in the long term.

Where’s the best place to start?

Before you get started, make sure to visit a financial consultant, either in person or online, to get the best advice about trading. By reading about the basics of risk management and getting professional advice, you will better prepare yourself for the world of finance and investment. 

Trade with a plan

Reading up on key trading tools and concepts such as stop-losses and take-profits is important for new traders. While experienced investors have learnt over time how to wield these tools, newbies often stumble into trades without knowing what to deploy or when. According to trading experts, a good starting point is knowing exactly when you will close your position for a profit or a loss. 

Inexperienced traders without a clear plan for selling lots struggle to make hard and fast decisions, and even worse, let their emotions take control. While you may be frustrated with how your trade is panning out, you should never let it cloud your judgement or influence the frequency of other trades. This is how large losses are racked up. The flip side is also true. You need to know when to take a profit and not try to eke out even more gains. Planning your trades is the first step to effective risk management.

Adhere to the 1% rule

Bankroll management is another key concept that new traders should familiarize themselves with. The capital you have to your disposal dictates the size of your trades and the stock and foreign currencies you buy into. For this reason, it is a good idea to limit the amount of capital you use for a single trade to guard against downsides.

Day traders usually follow the ‘1% rule’, where only a single percentage of their total account value is used for each lot. This means that if you have $20,000 in your account, you would only risk $200. While this may appear to be a small sum, it will protect your capital if you suffer a string of losses. In this instance, you would have to lose 100 trades in a row before your account is closed.  

Diversify your portfolio

Experienced traders also learn that it’s not preferable to put all of your eggs in one basket. While you may be bullish on a specific stock, you run the risk of a big loss if you focus solely on a single lot. This is because assets that are heavily weighted in one direction can become very risky depending on how the market evolves. Diversifying your investments across different sectors, company sizes and markets will lower risks while giving you a better chance of yielding higher returns. 

Use stop-losses

Wielding trading tools effectively takes time, but you need to practice using stop-losses and take-profits when you first start out to control your trades. Getting out of the market at the right time is what trading and financial management is all about. Experienced traders know exactly when to bail and minimize losses and sell to maximize profits. They don’t just do this manually though – they use automated software features.

A stop-loss order will buy or sell an asset at a set price. This would see you, for example, set an order to sell when a stock goes 5% down on its current price. You can decide on the sell ‘points’ by conducting fundamental analysis and reading charts. When you become more experienced, you can start using these tools based around support and resistance trends to stay one step ahead of the market.

Calculate returns

Active traders also know that it is not a good idea to enter a trade without knowing the expected returns on that trade. This calculation will help you rationalize your moves and take sentiment out of your decisions. You can also use the expected return figure to compare it with other stocks and assets. By adhering to these risk management tactics, you will be able to manage your accounts effectively as you gain more experience in trading.

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The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.