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"Introduction to Risk Management"
Risk management is an integral part of any trader's work. Learn the basics of risk management and learn how to apply them in your trading plan.
Why risk management is an important part of trading;
What are the elements of a successful trading strategy;
Risk ratios and trading strategy.
Risk management is one of the key concepts for long-term success in the financial markets and also one of the most overlooked aspects of trading. But why is risk management so important, and how can you implement it in your own strategies?
You can be a talented trader who can easily predict price movements and make great profits, but without a risk management system, you can suffer serious losses.
It doesn't matter how good or experienced you are, you will still be faced with losing trades. Even the best traders in the world sometimes suffer losses as this is an integral part of trading. This is why risk management is critical to your trading.
Risk management rules are easy to understand even for beginners, but in reality they are not easy to follow. It is very difficult to turn off emotions when real money is at stake.
Before getting into specific risk management techniques, let's look at the basics of money management as an essential element of a successful trading strategy.
Elements of a Successful Trading Strategy
A correct trading strategy usually consists of three important elements.
A trading system is a consistent application of the rules by which a strategy is built. In fact, a trading strategy is a set of methods by which you determine the point of entry into the market and exit from the transaction. These methods also help to understand the current trend.
You may be using moving averages to identify a new trend as early as possible. Stochastic indicator to determine if it is safe to enter a trade after a moving crossover. You can also use the RSI as additional confirmation to help determine the strength of the trend. In any case, your trading strategy should be unique, since all trading strategies are individual.
Control your emotions. Your trading strategy has shown itself well on a demo account, now it's time to try trading on a real account. However, there is a significant complication here. Our emotions, namely fear, greed or anxiety, will in every possible way prevent us from implementing a pre-planned plan, potentially causing losses. It is important to remember that you should not panic and make hasty decisions. Allow profits to grow, and try to fix losses early.
Capital Management. The size of your leverage, the size of the trading lot, setting Stop Loss and Take Profit, all this is related to risk management. Good money management is an important part of successful long-term trading. This helps to maximize any profit while minimizing losses. It also prevents taking too much risk.
As you can see, proper consideration of these elements will play an important role in your ability to trade successfully. If you only use two of the three elements above, you may run into avoidable failure. One of the keys to trading is staying “in service” as long as possible.
What are the elements of good money management? Here are some methods that can help control your risks:
- The size of your position;
- Hedging - opening deals for one asset in opposite directions;
- Trading at certain hours;
- Stop Loss and Take Profit.
Let's look at an example where one of these elements is ignored. Suppose your account has $ 6,000 and you are selling EUR / USD with a trade size of 5.00 lots and a leverage of 1: 100.
You use most of the funds in your account in this single position, leaving no room for maneuver in the event of negative price movements. Each move in pips will result in a $ 50 profit or loss. In fact, you are using a lot too large for trading, which does not fit the $ 5000 deposit.
Let's see what will happen next. Some data is emerging, the markets are reacting with the strengthening of the euro, which is growing by more than 50 pips against the dollar. This step results in a loss of $ 2500 trade in minutes, which is half of your funds. You only have a part of the money left to restore your account.
You need to decide what the next move will be: close the trade to prevent further losses, or reduce the position size. Then there is another 50 pips move against you, which means that you will suffer a loss of $ 2,500. So the total loss is $ 5,000 for a 100 pip move against you.
This transaction is a prime example of a position that does not comply with the rules of risk management. It clearly shows how dangerous such transactions can be for your account.
Management of risks
Sometimes even the best traders suffer losses at certain times, this is an integral part of trading. The secret is to limit your losses to a more manageable level. Thus, you will find that you can stay in the market longer, increasing your chances of better trades.
One of the ways to achieve the right balance between profit and risk is to make profitable trades, in which the profit is 2-3 times more than the maximum risk. In this case, even if you suffer 3 losing trades, you only need 1 winning trade to completely cancel out the loss. This rule will help us present a specific approach to risk management.
Example: Let's imagine a trader who decided to try his hand at trading with an initial capital of $ 10,000. He follows all the rules of a trading strategy, controls his emotions, does not violate risk management. But due to the low level of practice, his trading statistics are not very successful.
Let us assume that a trader has made only 30 transactions in a month, of which only 10 were successful. This is 33.3%, which indicates very bad statistics. But at the same time, each deal was opened with a risk / reward ratio of 1: 3, Take Profit and Stop Loss were always used.
Each losing trade resulted in a loss of $ 100, and each profitable one brought in $ 300. After doing some statistical calculations, we can see that 20 losing trades resulted in a loss of $ 2000, but 10 profitable trades brought $ 3000 in profit. The trader not only covered the loss, but also made a profit of $ 1000, which is 10% of the initial capital.
An important part of trading
Risk management can be an important part of trading. An experienced trader knows how much he can risk. But you, as a beginner, should do your best to avoid serious losses.
Losses are part of the trade, they are inevitable, and it is important to know how to deal with them. Profit management is another critical aspect. A successful trader must find a balance between the results of the transaction: maximizing profits, minimizing losses.