What Are the Different Risk Management Techniques Used In Trading?
While trading can often seem like a complex venture, it offers an ideal way for traders to get profits not just for the short term but over the long run. The trick to getting the most out of this will, however, be setting up a risk management strategy, making it possible to cushion yourself from unexpected market price fluctuations. So, what are some examples of risk management strategies that can help protect your trading profits?
Utilize a Trading Plan
While this may seem cliché, planning will be the most important technique to help keep your profits intact. One of the well-known phrases used in trading is “Plan the trade and trade the plan,” a guiding quote used by traders, and with good reason. Planning allows you to evaluate broker authenticity, credibility, and prices charged for commissions. Check out Zenfinex for more information about forex trading.
With this in mind, research the type of broker you prefer working with. Are they the right pick for consistent trading? Do they offer insightful tips when you need assistance with your trading portfolio? Additionally, consider their commissions, with significant gains often being a red flag.
A trading plan will also involve identifying the proper stop-loss and take-profit points. Before starting your trading, make it a point first to plan the price you are willing to pay for any trade and the cost you intend to sell. This will help you measure your adjusted return, with high returns making the trade-off worth it.
Diversify and Hedge
As a rule of thumb, never put all your capital in one instrument or stock, as this will expose you to significant risks. Diversifying your capital will be another vital risk management technique to consider utilizing. Consider looking into multiple investment options across the industry sector and market capitalization and, where possible, across different geographic regions. Based on your analysis, choose three or more options, as these will also give you more room to venture into new opportunities that you may not have considered investing in.
Hedging is another technique that gives you room to protect your position. You can pick a stock position when the trading results are due, after which you can take the opposite position by utilizing options. Once trading subdues, you can unwind the hedge, allowing you to limit losses per your trading preferences.
Set Up Your Stop-Loss and Take-Profit Points
As previously stated, stop-loss and take-profit points will be essential for managing your risk levels when trading. A stop-loss point refers to the price at which traders sell their stock and incur a loss on the trade. Setting this up allows you to avoid emotional holding of stock with the hope that prices will be favorable again. This will be important in helping you prevent losses before they get worse, with well-calculated points making it possible to sell as your stock falls below a defined target.
On the other hand, a take-profit point refers to the price at which a trader sells their stock and makes a profit. Setting this point limits any upside movement, due to the risk it comes with. When a stock approaches a key resistance level, traders will often make a sale before consolidation takes place, avoiding losses in the long run.
Tips To Help You Set Your Stop-Loss and Take-Profit Points
Setting up a stop-loss and take-profit point requires some experience, with the following guide providing helpful tips for trading:
- If you have volatile stocks, consider using longer-term moving averages. This allows you to reduce the possibility of triggering a stop-loss order when a sudden price swing occurs.
- Use moving averages to set your points. These will often be easy to calculate and are some of the most prevalent methods used on the market. Essential moving averages to consider are the 5-, 9-, 20-, 50-, 100- and 200-day averages.
- Adjust your moving averages and match them to the target price ranges. If you are using longer targets, make it a point to match these to larger moving averages. It will help you reduce the number of signals generated for better trading.
- Work with known fundamentals when trading. An example is using earnings releases for time periods to set when you are in or out of a trade. This minimizes your chances of running into uncertainty and volatile periods.
- Your stop-loss point should reflect the market’s volatility. If the stock price has minimal movement, tighten your stop-loss point with increased activity, requiring you to adjust the points.
- Place your stop-loss and take-profit points on resistance trend lines or on support. Identify the level at which the prices react to these trend lines, preferably on high volume.
- Ensure that your stop losses are not closer than 1.5 times when using the current high-to-low range volatility. Doing this will trigger the stop-loss point without any valid reason.
Calculate Your Expected Returns
After setting your stop-loss and take-off profits, make it a point to calculate your expected return. Doing this allows you to compare various trade options and strategize on the most profitable stocks for overall reduced losses. To do this, multiply the profitability of your gain by the take profit percent of your gain. Add this to the result you get after multiplying the probability of loss by the stop loss percentage.
If you are a new trader, the probability of loss or gain can be calculated by utilizing the historical breakdowns and breakouts from the support. The resistance levels can also help with this, with experienced traders able to make educated guesses about these figures. What Are the Different Risk Management Techniques Used In Trading
Use the One Percent Rule
The one percent rule implies that you should never put more than 1% of your trading account or capital into one trade. Instead, diversify your capital to multiple instruments to lower your risk of losses. This rule will especially come in handy if your capital is less than $100,000. If you have more capital, the rule allows you to go as high as 2%, with no more likely to result in significant losses. Take note that the size of your account increases your trading positions, hence the reason it is always best to keep it below 2%.
Consider Downside Put Options
If you are interested in options trading, consider buying a downside put option or a protective put. This technique protects your account when a trade does not go according to plan. A put option gives a trader the obligation but not the right to sell preferred stock at a given price at or before their underlying option expires. This cushions you from any price drop below your stipulated put option, preventing significant losses on your trading account.
If you are interested in becoming a trader, having a plan will be one of the essential parts of getting the most out of your account. Make sure to follow this up with efficient stop-loss and take-profit points, as this will be vital in helping you reduce your losses. In addition to this, make the one percent rule part of your trading strategy while utilizing put options and diversification techniques in your portfolio.
What Are the Different Risk Management Techniques Used In Trading?