The Importance of Risk Management for Trading Success: Just as Vital as Maximizing Returns.
Risk Management In Trading
Risk Management has always been a crucial part of trading. Successful trading is not only dependent on the right prediction of the trend but management of risk is also the major decisive factor. Risk Management is a must strategy for a successful long term trading career. In the absence of good risk management skills, many good traders have fallen down several times. Risk management may not be the topic of interest for novice traders because it does not secure the return but restricts the loss. But exiting the market by avoiding loss is also gain. Novice traders are always in search of the holy grail factor which will always give them gains on every trade they enter into. They focus on maximization of profit rather than minimization of loss. In the expectation of high profit, they take higher risk, way out of their risk appetite. Their emotion guides them to emptying their trading capital resulted from the continuous loss.
Why Risk Management Is Important?
Researches say that after 8 trades there is a major chance of 3 continuous loss, after 16 trades there is a chance of 4 continuous loss and after 32 trade there is a chance of 5 continuous loss. So risk management is as important as market analysis and placing the right trade. A series of right trades may turn into a wrong trade as a bundle without a good risk managing strategy.
The trader should enter into the trade by being mentally, emotionally, and economically aware of the chances of loss. S/he should not ignore the possibility of loss. The market is mechanized in a way that most of the traders lose and only some win. Trading overall is a negative-sum game. The winner wins less than that the loser loses because of several factors such as brokerage, taxes, and other fees.
Experts say that even a very successful trader has a hit rate of 60% to 70%. This simply means successful traders also lose 30% to 40% of their overall trade. But the question is how they are so successful even after losing 40% of trades. The answer to this is simple, they are successful risk managers. They limit their risk size. This makes their loss smaller. The series of larger gain and smaller loss finally leads towards successful trading. Walking five steps forward and 3 steps backward finally lead a person to two steps forward. This is the secret mantra of successful trading. We cannot expect to move five steps forward only. Stepping 5 steps upward may lead the trader to fall into the abyss.
How To Manage Risks In Trading?
Risk management starts before trading. At first, a certain amount should be set aside as trading capital out of disposable income or savings. No trader should start with undecided capital. Starting without deciding the exact amount of trading capital may lead to the injection of a higher percentage of wealth into trading. Loss of which may lead to the loss of a higher portion of wealth. Likewise, no trader should start trading with the loan amount. Loss of which may lead to bankruptcy. If a trader enters with a trading capital of $1,000 then it can be from his savings or he may gradually plan to increase his trading capital to such an amount by contributing from his disposable income monthly. The capital may be dynamic. Upon the gain, the trader may increase capital.
The next thing on risk management includes trading limits. The trader should not put total trading capital in a single trade. Diversification of funds is a must. There is common practice throughout the world that at most 10%-15% of trading capital should be invested in single trade i.e. if the trading capital of any trader is $1,000 then s/he can invest at most $150 in one trade.
Similarly, risk-taking is another thing that needs to be looked into in risk management. A trader should not risk more than 2% of his trading capital in a single trade. Commonly, experts suggest a 1% risk on capital but if the trader is confident on his trade and his indicator is giving a positive indication, then he can take a 2% risk at most. This means that when the value of his trade declines by 2% of the trading capital, s/he should cut her/his losses and get out of that trade.
Conclusion
To sum up the points, risk management is a must-use tool for all the trading career. The trader should start with deciding trading capital and risk tolerance. Risk tolerance may differ from one to another person. It is affected by the income of the trader, investment objective, investment experience, and many other factors. The trader should constantly try to enrich themselves with knowledge. Knowledge and information are the greatest power in the field of trading. You can fetch more and more capital from your knowledge.
