Trading in the financial markets can be a risky endeavor, but with proper risk management, traders can minimize their losses and increase their chances of success. Developing a risk management plan may seem daunting, but there are six key strategies that traders can follow to manage risk efficiently.
- Determine Your Risk Tolerance Every trader has their own tolerance for risk. It is recommended that traders risk no more than 1% to 5% of their account value on any given opportunity, but traders should ultimately decide how much they want to risk based on what makes them comfortable. As traders become more comfortable with their trading systems, they may be tempted to increase their risk percentage, but caution should be exercised to avoid risking too much. The goal of trading is to either realize a return or maintain enough to make the next trade.
- Size Each Position Correctly Once traders know how much they can risk on any given trade, they should plan the size of their positions accordingly. Balancing risk and reward is essential in trading. If a trader is risking a small amount of money on a trade, they should not purchase a large number of shares or contracts, as even a small price movement could cause them to reach their risk tolerance for the position. Traders can learn about the contract sizes for their chosen asset classes to make sure they are getting as close to the amount of money that they want to risk on each trade.
- Determine Your Timing Traders need to decide how much time they want to spend trading each day and when they want to do it. This helps them get in the right mindset for trading, which can be useful for managing risk. Exit orders and alerts can be used to manage risk when traders are not fully focused on the markets.
- Avoid Weekend Gaps Most markets close on Friday afternoon, which means traders should have a plan in place for how to manage risk over the weekend. Markets are still moving throughout the weekend, and may have moved drastically by the time traders can trade them again. These gaps can move markets beyond traders’ stop-loss levels. A good risk management plan should outline how to mitigate this risk, such as by closing positions or upgrading stop-loss orders to guaranteed stops.
- Watch the News News events can significantly impact markets, causing abnormally large moves or sudden gaps. Trading after these volatile events requires careful risk management. Unless traders are specifically looking to take a strategic risk by placing a trade around a news event, they should take steps to protect their positions from unexpected market movements.
- Make it Affordable Traders should never invest more than they can afford to lose. Trading can be risky and difficult, and putting one’s own livelihood at risk on the machinations of market dynamics that are difficult to predict is rarely a good idea. Traders should invest in a way that is intelligent and consistent, avoiding the temptation to gamble away their hard-earned trading account.
In conclusion, developing a risk management plan is essential for any trader. Following these six tips can help traders manage risk efficiently, balance risk and reward, and increase their chances of success in the markets. By determining their risk tolerance, sizing each position correctly, deciding on their timing, avoiding weekend gaps, watching the news, and making it affordable, traders can trade with greater confidence and achieve their trading goals.
