Understanding Risk Management

Risk management, arguably, is one of the most important concepts that a trader must first understand before diving into trades. Managing your risk allows you to minimize losses and prevent you from blowing your account up. Risk is defined in financial terms as the chance that an outcome or investment’s actual gains will differ from an expected outcome or return. Risk includes the possibility of losing some or all of an original investment. Are you going to be able to handle a loss if a trade goes your way? If the risk can be managed, traders will have a better chance at being able to make money in the market.

Jumping Into Trades

The stock market has been around for decades upon decades and it will be here tomorrow and the day after that. The point is, the market will always be here as long as society is still functioning. That being said, there is always an opportunity to make a trade in this market. There is no need to risk your account on a trade you are not confident in. Everything should follow a specific strategy when it comes to entering and exiting a trade, including identifying potential entries to make.

FOMO – Fear of Missing Out

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It is human nature. There is a million dollars right down the street but only available for a limited time, but in this case if you stay for too long you have to pay a fine.

What are you doing?

Relating this to trading, there are also ‘breakout’ opportunities that occur daily in the market. Some stocks might decide to move 20 points within a short period leaving you questioning yourself as to “why you didn’t buy in” or even telling yourself “I knew this was going to happen!” Trust me, I’ve been there.

It is important to learn to not chase trades as most of the time when this occurs, you have no plan and you’ll end up getting caught on the reversal more often than not. If you get into the trade, how are you going to know when to take profit? Save your capital, live to see another trade. After all:

Cash is King | Pryor Learning Solutions

Entry

Depending on the strategy you are trading with, it is important to not enter trades randomly. You could be expecting a reversal based off a bounce from the support or resistance level, or you could be noticing a momentum increase from the stochastic cross. Either way, you understand everything the moment you get in the trade.

Important

You are in this for the long run! 90% of traders lose. Be the 10%. You will not be a millionaire overnight!

Risk Capital

This is an amount of money that you would be comfortable losing and if it is lost, would not affect your current financial situation. It is a completely personalized number that you decide on by asking yourself how much of your total net worth would you be comfortable losing. This is one of the most important decisions for any trader.

The reason is because, if this number is too high, then it will be nearly impossible to stay discipline and consistent in trading.If you are risking everything you have, then it is going to be very difficult to recover from an inevitable drop that all trading strategy come with.

Risk Per Trade

Each trade should have a planned amount of money that you are willing to risk each time you place a trade. This is also completely personalized as some people have a high-risk tolerance while other have a low-risk tolerance. This decision extremely affects your decision about risk per trade.

It is advised for new traders to only risk 1% maximum per trade. The percentage of risk also depends on the account size since most smaller accounts will have to risk a bigger percentage of their overall portfolio. This helps control emotions and keep a profitable mindset when trading.

Risking a good chunk of your net worth is surely a recipe for disaster.

Maximum Exposure

From your entire portfolio, this is the overall amount of money that you are willing to risk at one time. Having multiple positions opened at one time could play well for you, but note that this can be stressful and overwhelming to manage a lot of positions at once. If the entire market decides to drop, then the stocks that correlate with each other will take down your entire portfolio with it.

After deciding the risk per trade, it is important to also consider your maximum exposure. If you only want to risk 5% of your account at one time, you would only have five 1% positions open at one time.