6 Fundamental Strategies
for Risk mangement
1. Know your Appetite for Risk
First things first, know your own appetite for risk, this will help you make better logical decisions when you are doing some real world trading with real money and prevent you from being too reactive to the highs and lows of the market. It will give you more control of your financial situation and overall help you sleep better at night.
2. Control Your Leverage
Being able to use leverage in trading is a double edged sword, while it can greatly increase your profits it can just as easily magnify your losses as well. Let’s say for example you have an account worth $100, with a leverage of 1:1000, that allows you to place a trade worth up to $100,000. If the market swings in your favor you will experience the full benefit of that $100,000 trade even though you only invested $100, however the reverse is also true if the market swings against you, you can just as easily have your entire account wiped out.
To avoid exposing yourself to high levels of risk, specially if you are a beginner, try not to use high leverage in your trading. Use only leverage when you have a clearer understanding of the potential losses you may incur. By doing this you will not suffer major losses in your portfolio. Understand the benefits and trade-offs of using high, middle, and low leverage rates in your trading strategy.
Here at bulletproofforex we advertise sticking to the low and middle level leverage range, specially when you are just starting out, until you can get a better feel for forex trading, enhance your skills and expertise, that is an invaluable asset, then if you really want you can try moving up to higher leverage rates, or not, its perfectly fine to just sit in the lower and middle level ranges as well.
3. Always use Stop Loss
The concept of a stop loss is fairly simple and direct, you set up a limit to the maximum losses you are willing to take and automatically close that position when a trade hits that threshold. The benefits of a stop loss order is that it allows you to stop a bad trade in its early stages before you start losing more money or before it breaks out into a major financial calamity.
Setting up the threshold for “stop losses” however is where hard work and experience comes in. More experienced and technical traders setup a stop loss after considering the high and low average over a certain period of time of a particular currency pair they are looking to invest in. They go the extra mile, do the work, do the research, review the previous trends in the recent weeks, read on news relating to the subject, analyze certain movement patterns then decide the threshold for their stop loss. As a beginner you can just as easily do this too.
In summary, either method is fine, you can set it up as a blockade to future losses, or as the extreme low you are willing to accept based on your research. Nevertheless setting up stop losses should be at the core of your trading strategy. This will minimize your risk and protect your investment.
4. Keep your Reward/Risk Ratio 2:1
If you’re like most people you probably havent heard of the risk/reward ratio, so let’s go over that right now with a simple example. Let’s say you have $100 in your account, after investing you were able to pocket a total of $200 doubling your initial investment (reward), at the risk of losing your initial investment of $100 (risk), that is a 2:1 Reward/risk ratio. Similarly if you earned $300 on that trade the ratio would change to 3:1.
To calculate your reward to risk ratio (RRR), simply divide your net profit (the reward) by the price of your maximum risk. Let’s take another example, say you have invested $500 and the price you are willing to risk stands at $100, the ideal net profit for you to achieve this ratio would be $200. So in total you have $500, your ideal net profit is at $700 for risking a maximum of $100, this will give you a better idea on what numbers to shot for while minimizing risk.
Alternatively, let’s say you are willing to go all in for your $500, and made $700, what is your RRR?
$700/ $500 = 1.4 or a reward to risk ratio of 1.4:1.
To effectively use RRR (probably one of the most important metric to measure in your trading strategy) follow these steps:
1. Pick a currency pair using exhaustive research.
2. Set the upside and downside targets based on current price
3. Calculate the risk/reward ratio
4. If it is below your threshold, raise your downside to attempt to achieve an acceptable ratio.
5. If you cant achieve an acceptable ratio, start over with a different investment idea.
When you start applying these techniques to your trading you will quickly see how difficult it is to find a good investment opportunity. But power through and you’ll eventually find those deals which are worth investing in.
5. Control Your Emotions
Learn to control your emotions whenever you place a trade in the market. There are two highly emotional events in particular which you should watch out for.
1. Getting greedy for more profit when its time to get out.
2. Not letting go and cutting your losses in hopes that a losing position will come around.
There are other variations as well:
1. Pulling out too early when things are going good when there’s more profit to be had.
2. Pulling out at the first sign of the trade dripping down low.
The solution? Learn to discipline yourself and follow a systematic plan of action and stick by it, this will be a lot better for you in the long run, than letting your emotions get the best of you.
By having a diverse range of investment you protect yourself in case a few of your trading positions experience losses. Hopefully, your losses will be covered by other trading positions which are performing better.