Risk Management Techniques
Risk management techniques are crucial to your trading strategy success.
Being able to apply these techniques at the right time will help you to achieve your targets.
A trade plan is a set of rules or guidelines that manages how you trade. You have to follow them and it will allow you to:
1.Make sure that your trading is consistent
2.You can easily track its performance.
1.How do you set up a trading strategy?
There are a few things that you need to determine to set up your trading strategy.
- When will you be able to trade?
- What instruments will you trade?
- Trade setup. What analysis technique will you use?
- How will you determine the market direction?
- How will you determine your entry?
- How will you determine your exit?
- Risk management.
- How much will you risk per trade?
- How much market exposure will you have?
- Trade execution.
- What determines your actual buy or sell decision?
- Trade management.
- Will you add to or remove from your position?
- Will you reduce the stop loss?
If you can answer all these questions and be consistent in the way you execute your strategy, then you’ll be able to better manage your risk.
2. Diversify your portfolio
Diversifying your portfolio means buying different instruments. You can diversify your portfolio within an asset class or you can diversify by trading all asset classes.
Diversifying within an asset class
This entails taking positions in instruments that aren’t directly connected.
Diversifying in trading Forex
If you trade forex with Stockhome you have access to any currency pair you want . If you were to take several positions in currency pairs that contained the US dollar, then you would leave yourself exposed to how each different currency behaved.
If the USD were to become strong off the back of an interest rate decision and you had sold it in several currency pairs then you would be looking at some negative balances on your trades.
It’s therefore important to make sure you know exactly what currencies you have exposure to. If you had two positions in two different USD pairs at 0.5% risk, and you decided to take one more of the same risk, you would have 1.5% reliant on what the USD would do. It might therefore be better to look for another position in a pair that doesn’t include the USD.
Diversifying in trading Stocks
If you had a portfolio of stocks, diversifying away from one sector would reduce your risk.
Spreading your risk across several sectors can protect you from catastrophes.
You can also diversify between asset classes. When trading with a broker like Stockhome, you have five different asset classes available, so you can better spread your risk.
Whilst all markets are interlinked, they do move separately. Factors that affect oil are less likely to affect GBP/USD or bitcoin for example.
3. Use trading tools
There are lots of trading tools that you can apply to your risk management strategy. Below are a few types to start thinking about:
These offer trading signals based on mathematical equations. These let you know when you should enter or exit a trade. They would normally be used as part of your trading strategy if you used technical analysis as your main approach.
This will show you when market-related news is due to be released. Depending on the release, your research will tell you which market it might affect.
Trading service tools – Our Stockhome platforms will offer advanced order types that will help you manage your trades and your risk.
you can use an automatic trailing stop.
Note that you should only use a tool like this if it is in your strategy.
4. Calculate your costs
You must continually reassess your trading expenses to ensure you’re not paying more than you should and need to.
Overtrading can have a devastating effect on your bottom line.
How do you calculate your additional costs?
You will incur three main charges when trading through a broker:
- •Spread - difference between the bid and the ask price•Commission - the set amount charged to take a trade•Overnight charges - the fee you pay to hold your position overnight on leveraged trades
Now you need to understand which applies to you and your trading account.
This will depend on the instruments you trade and the account you have with Stockhome. Understand how much you are charged per trade and overnight.
Determine how often you trade and whether you hold overnight positions
Average the number of trades you take per day, per week or per month to give you an idea about the volume you trade.
The moment you have this figured out and you have your volume and cost per trade, you can then multiply and understand your costs of trading and see if another account with Stockhome would serve you better..
5. Keep Control of your emotions in check
Trading psychology is one of the hardest things to manage in trading forex or any other financial assets.
This is an issue pretty much every trader has to deal with.
All the financial markets can be accredited to different states of psychology.
The market moves in cycles and you can attribute different emotions to different periods in that cycle. The following emotions you will find in individual traders as well on a macro scale of larger economic metrics.
And as long as traders feel like this the market psychology will reflect this.
How do you keep your emotions in check?
Trading plan - Set yourself a trading plan and stick to it. It is the first step to trying to control your emotions
Record your trades - Keep a track record of your trades. you’ll see your performance in black and white and without the emotions.
Automation - Taking the emotions out of trading and letting a robot do it for you. If you can set up a strategy that has just a few variables then you’re more likely to be able to stick to your trade plan and risk management strategy.
Setting stops and take profit limits are forms of automation as your platform can be programmed to execute your instructions when certain levels are triggered. If you also select your entries through automation, then you have no reason to intervene in your trades manually, therefore removing emotions.
6. Only risk money you won’t miss
Don’t trade with money you need to pay the bills. Remember, it doesn’t matter how small your account size, you can always add funds to your account once you gain experience and confidence.
Don’t put all your savings into a trading account. Instead, decide what portion of your savings you can risk. Are you happy to lose say 10% to learn to become a better trader and have the potential to earn 15% back?
Think about the fact that you are leaning something new and there is a learning curve. Like any education a good one cost money, so does starting to trade.
7. Consider your risk tolerance
Your tolerance of risk depends on your ambition and your psyche. You will only discover what it is once you expose yourself to live market conditions with real money at risk. If you find yourself sweating over results, and manually interfering too early thereby corrupting your trading plan, perhaps you need to dial down your risk per trade.
8. Set realistic risk-reward metrics
it is not realistic to target a 200 pip move in the current session to capture 1:5 risk-reward (profit). This will bring disappointment and will negatively affect your trading.
9. Keep your risk vs reward consistent
Beginners find it very tempting to increase their risk when they’re in a winning position, but they often fail to adjust the risk when they’re in losing situations. Over trade and micro-manage. Let your trading plan do what it is supposed to do, if it works you can enlarge the amounts and exposure and still not micro manage
10. Understand margin and leverage
Using leverage allows you to trade more money than your initial deposit because of margin trading. Leverage increases your profits, or losses. You need to understand how leverage and margin impacts on your overall performance and trading.
Update your risk management plan as you become better traders
While sound money management needs to be a permanent feature of your trading plan, your risk management technique should not be permanently set.
Your feelings towards risk will change as your trading develops more and more. Your risk parameters will then change as your trading changes.