Using Orders to Manage Risk
When it comes to trading, risk management is crucial. It is important to have a plan in place to limit losses and protect profits. One aspect of risk management is using orders to manage risk. Exit orders, such as stop orders, take-profit orders, and trailing stops, can help traders stick to their strategy and avoid making emotional decisions in the heat of the moment.
Stop Orders Stop losses are a popular order type used to limit losses and manage downside risk. They help keep traders in line when a position is in the red. Without a stop order, traders may fall prey to the ‘just one more’ bias, where they want to believe that a turnaround is on the cards and don’t want to accept that they got things wrong. Stop losses not only protect traders if a market suddenly reverses and they aren’t able to manually close their position, but they also act as an additional line of defense against ‘just one more’ thinking by automatically closing a trade if it hits the maximum loss level. Traders should consider upgrading to a guaranteed stop to eliminate the risk of slippage.
Take-Profit Orders Being in a winning position is a fulfilling feeling when trading, but human emotion can be dangerous on the markets. Two issues often plague traders who are sitting on a winning trade: reluctance to exit the position at the right level and the desire to exit the position and realize profits immediately. Using a take-profit order at the profit target can help traders keep discipline and stick to their plan instead of going off track. It reminds them to avoid irrational thinking and helps them protect their profits.
Trailing Stops Trailing stops can play a unique role in a trader’s risk management strategy by enabling them to limit downside risk while protecting profits. Trailing stops follow a position if the market moves in a trader’s favor but remain in place if it moves against them. They help limit losses to a set number of points from the current price of the market. Traders can use a trailing stop in a similar way to a standard stop when opening a position. However, it may not always be the right option when it comes to controlling risk. Markets may see significant volatility on their way to hitting a profit target, which could mean that traders undercut their returns from a trade with a trailing stop.
In conclusion, using orders to manage risk is an important part of a trader’s risk management plan. Exit orders such as stop orders, take-profit orders, and trailing stops can help traders stick to their strategy, limit losses, and protect profits. When creating a risk management plan, traders should consider which tools they’ll employ in which situations. Using these orders correctly can make a big difference to a trader’s overall bottom line.