Stock markets offer many opportunities but also contain many risks. If you want to become a successful trader, it’s crucial to learn risk management. It will help you cut down losses and enjoy more gains. Besides, such tactics can also help you protect your account and avoid losing your money. The risk typically occurs when the investor suffers a loss. However, if they can manage this process, the investor can open themselves up to gaining money in the market.
Risk management is essential but, unfortunately, often overlooked prerequisite to successful active trading. An investor who has generated substantial profits can lose it all in one or two bad trades if they don’t employ a proper risk management strategy. But how can you develop the best techniques to avoid the unnecessary risks of the market? Here are several simple strategies that you can use to protect your trading profits:
First step: Plan your trades carefully
Every battle is won before it is fought – said Chinese military general Sun Tzu. As this phrase implies, strategy and planning—not the battles—win wars. Experienced investors often quote the phrase: Plan the trade and trade the plan. They know that planning ahead can mean the difference between failure and success.
You should make sure that your broker is right for frequent trading before plunging ahead in the market. Some brokers cater exclusively to customers who trade infrequently. However, they charge high commissions and don’t usually offer the right analytical tools for active traders.
Take-profit (T/P) and stop-loss (S/L) points are two key ways in which investors can plan ahead during trading. Furthermore, it’s important to know what price you are willing to pay and at what price you are willing to sell. After such calculations, you can measure the resulting returns versus the probability of the stock hitting your goals. You should execute the trade only if the adjusted return is high enough.
Step two: Remember about the One-Percent rule
Many day traders follow the one-percent rule, which suggests that you should never put more than 1% of your trading account or your capital into a single trade. Let’s say you have $20,000 in your trading account. In such a case, your position in any given instrument shouldn’t surpass $200.
This strategy is more common for investors who have accounts of less than $100,000. Some of them even go as high as 2%, but only if they can afford it. Meanwhile, many traders whose accounts have higher balances may prefer to go with an even lower percentage, as they take into consideration that when the size of their account increases, so does the position.
Remember that the best way to decrease your losses is to keep the rule below 2%. If you bet more, you’d be risking a significant amount of your trading account.
Step three: how to set Take-Profit and Stop-Loss points
Let’s explain the terms first. A stop-loss point is a price at which an investor will sell a stock and subsequently take a loss on the trade. This is an often occurrence when a trade does not pan out the way an investor hoped. The points are specifically designed to limit losses before they escalate. For instance, if a stock breaks below a key support level, the participant can often sell as soon as possible.
A take-profit point is a price at which an investor will sell a stock while making a profit on the trade. In such a case, the additional upside is limited, considering the risks. As a result, if a stock is approaching a key resistance level after a large move upward, investors may prefer to sell before a period of consolidation takes place.