Trading is a risky business, and although many new traders enter the fray knowing this, they often start with assumptions that can lead them to make poor decisions.
You don’t need all your trades to be winners to make money from trading. You just need to make sure that your total wins outweigh your total losses. To increase the likelihood of this, the question on your mind in any and every trade scenario should be “how much can I afford to risk?”
It’s best not to concentrate on making huge sums of money fast. Instead, think about how best you can take control of a situation that can easily turn volatile. In this article, we’ll walk through the essential steps to manage your risk when trading the markets.
Use stop-loss and take-profit orders
One way to reduce risk is deploying stop-loss orders. These place a limit on the amount of money you could lose as a result of a trade. Stop-loss orders will automatically close your trade at a predetermined level decided by you. This gives you control if a trade doesn’t go the way you anticipated. In one trade, for instance, your asset may have begun to depreciate in price quite dramatically, and even though your rational brain is telling you to quit before it’s too late, the other part of you is eagerly hoping for a turnaround. The stop-loss order cuts your trade before you begin acting out of false hope, allowing you to avoid further losses, and swiftly move on.
Take-profit orders operate according to a similar logic. These encourage you to take profits at a predetermined level, instead of risking loss at a later point. Both order types help you stay humble and focused. If you want to have a look at how they work in action, Trade Nation’s trading simulator lets you use stop-loss and take-profit orders in a risk-free virtual marketplace.
Remember the 1% rule
Another unwritten law of trading is the 1% rule. When you’re new to trading it’s a good idea to limit your risk per trade to 1% of the total capital in your account. If you’re risking 1% of a £25,000 balance, winning half of your trades while making 1.5-2% profit, and minimising your losses, you’ll have a healthy net gain at the end of the day.
Diversify your portfolio
Putting all your eggs in one basket is always a risky move in trading. If you’re pinning all of your hopes on the value of one particular asset increasing and the opposite happens, you’ll be left with significant losses. For instance, if you have bought shares in both Starbucks and Nestlé, a shortage of coffee beans or disturbances in the supply chain and production may see your trades fall like dominoes.
Diversifying your portfolio reduces your reliance on one particular asset. By spreading your capital across different industries and countries, and trading on both large and smaller companies should ensure that your investments are unlikely to be affected by one another.
Plan and review your trades
Following a trading plan will encourage you to trade within your means and avoid being derailed by a sudden increase in market volatility. It will also discourage you from making risky decisions based on the fear of missing out.
By planning all of your trading activity and recording it accurately and honestly in a journal, you can carry out consistent reviews and assessments. This gives you a structure to analyse what tactics are working and which ones are not, as well as a space to summarise why you made these decisions.
For instance, what led you to trade a particular market? Why did you decide to buy or sell it? Perhaps most significantly, what emotional state were you in? Go to town on the details, because it will be useful in retrospect. Last but not least, if you’re honest with yourself about your market knowledge, you can be better prepared when it comes to your next trading decision. This will help you choose the direction of your trade, and also manage your risk by best deciding where to place your all-important stops and limits.
