Risk management is about measuring and quantifying the likelihood of adverse market effects that may affect our investments. In other words, it is about keeping risk under control.
No matter how good a trading strategy you have, you can end up losing all your money if you do not use proper risk management.
Financial risk management techniques:
- Limit the size of your trades according to your money management.
- Apply hedging strategies when necessary.
- Trade only during the best hours of the day, especially in the case of intraday.
- Limit the number of open trades at the same time.
- Determine in advance where to take profit and loss (stop loss and take profit).
We have already looked at the first two, so we will continue with the remaining ones.
Trade only during the best hours of the day
By this we mean that, especially in intraday, there are hours where there is more movement and hours where there is less. The same in Forex. This is also where the concept of volatility comes in, as we have already seen. Therefore, according to the strategy used, certain hours will be more convenient than others. Even certain days.
Also, in addition to this point, the trader trades at HIS best hours/days. If you are tired, in a bad mood, sleepy from a bad night, stressed or distracted, trading like this is the worst thing you can do, as it is more likely to make mistakes. Trading requires concentration and calmness. This also applies if you are feeling physically unwell, whether you have been ill or are in pain. Put trading on hold on those days, until you are better.
Limit the number of simultaneous open trades.
Using a small position size is always a good practice, but it is no good if you open too many positions at the same time because the risk will be higher.
It also depends on the style of trading, as it would be illogical to have 10 scalping positions open at the same time, whereas if we buy stocks on a long term basis we could have 10 positions (if our account allows it). It also depends on whether or not we use leverage.
The number of positions should be chosen by you, according to your risk level, trading style and account size. If you are starting out, it is best to demo no more than 3 or 4 positions. This way you can test and follow them. We will expand on this in the next lesson.
Determine in advance where to take profit and loss (stop loss and take profit).
One form of effective risk management is to control losses by using stop losses. The stop loss order should be set before opening the position. This order should limit the risk but not limit the opportunity for profit, so ideally the stop should not be too tight because it could be detrimental.
And as a golden rule: never move the stop loss if the market moves against you. If your stop is 20% of your trade, don’t lower it to 25%, and then to 30% because you think or assume it will reverse. This is how many novice traders lose more than they should, and in just a few trades they have no money left to trade with.
In future lessons we will look at how to determine the stop loss.