Risk Management for Traders
There are few maxims in trading held at all times and for all traders, but at least one concept will always be relevant to every trader.
That concept is risk management.
From a seasoned veteran to a brand-new beginner, every trader needs to know about and practice risk management if they don’t want to see their trading account get vaporized. The concept of risk management can be broken into smaller parts, and we want to do that today.
Essentially, we want to help any trader walk away with a better understanding of what risk management is, why they need to apply it to their trading, and how it can transform their trading philosophy and skills.
Only Trade Money You Can Afford to Lose
It is very tempting for new traders to dive into the world of trading as soon as they hear about it. They may expect that they can outthink the market and make profits’ no matter what. It is a great fallacy that many traders allow themselves to fall victim to. Sadly, when traders get out too far ahead of themselves and start trading with money that they cannot honestly afford to lose, things can get terrible quickly.
The problem is that when someone trades with money they cannot afford to lose, their trading psychology changes. They become highly worried about losing money, and they don’t make wise trading choices. People who trade money they cannot afford to lose often end up thinking about trading like gambling. They feel a huge surge of happiness when they win some wagers, but that happiness turns to anger and frustration when things turn against them.
The swings in one’s psychology can really impact how they trade in general, and things can get terrible for them in a hurry. Thus, it is necessary to consider all of the implications of your choices when you choose to trade beyond your means.
Always Use Stop-Loss and Limit Orders
When you place an order as a trader, you send the broker instructions to place a trade on your behalf. They will follow instructions and attempt to place the order at the best possible price, but you might not get the price you see quoted or even the price that you genuinely want if you don’t set the order up as a stop-loss or limit order.
What stop-loss and limit orders do for you is set pre-defined limits for how much you will gain or lose on a particular trade. You want to set these up before you place the order, so you don’t change your mind in the middle of the trade.
If a trade made sense at a certain price when you were thinking about it with a level head, then it shouldn’t change as the price movement comes into play. You will be much happier with your results if you stick to a pre-defined system that doesn’t deviate as the markets move around. Remember, there are a lot of bad things that can happen if you start to try to outguess the market.
Avoid Break-Even Stops and Fixed Stop Distances
Break-even stops and fixed stop distances seem like good trades to place on paper, but that is rarely the case.
A moving stop-loss order will shake you out of a trade more often than it will create the conditions for a winning trade. Thus, they should be avoided as much as possible. You are simply taking on too much risk with too little reward when you place this type of order.
Why many traders get taken out by the pros when they try to place these break-even stops:
Moving the stop loss to the point of the entry and so creating a “no risk” trade is a very dangerous and often unprofitable manoeuvre. Whereas it’s good and advisable to protect your position, the break-even strategy often leads to a variety of problems. Especially if you are trading based on common technical analysis (support/resistance, chart patterns, highs and lows, or moving averages), your point of entry is usually very obvious, and many traders will have a very similar entry.
Of course, the pros know that, and you can often see that price retraces back and squeezes the amateurs at the very obvious price levels, just before price then turns back into the original direction.
The world of trading can be cruel, and people will take advantage if they see that there is easy money just waiting to be plucked. Don’t make your money the easy money that they come after!
Additionally, you do not want to use fixed stop distances in your trading either.
Fixed stop distances take away the critical thinking that is such a vital part of trading. They promise to simplify trading, but what they really do is take a lot of the dynamic elements out of it. You are making assumptions about the market that are less than likely to pan out, and you are doing it all in a very simplistic manner.
Do not allow yourself to get sucked into thinking that fixed stops are the way to go. You are likely only costing yourself in terms of how powerful your trading really could be.
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