Do you know what the issue is with the majority of retail traders? Do the math – is it because they lack sufficient indicators? They are, after all, the ones who are familiar with the majority of indications, in some cases even more than professional traders. What other motive could there be? They don’t have access to insider information? The majority of us will not be aware of this until it becomes official.
Retail traders’ lax attitude toward risk management is the real reason they don’t make money in trading. This blog aims to shed light on this obfuscating truth in the world of trade. Let’s take a look at how to properly manage risk.
But, before we get into the how and why, are you familiar with the term risk management?
What Is Risk Management and How Does It Work?
Simply said, risk management is the holy grail of successful trading. To generate money while surviving in the market, risk management is even more crucial than profits. Why? Because even if you have a large amount of wealth derived through actual profit, it can all vanish in a matter of trades if risk is not well handled.
What Is the Importance of Risk Management?
“Give me four hours to fell a tree; I’ll use three to sharpen my axe,” says the narrator. This was once stated by Abe Lincoln. And it’s undeniably accurate.
The following are some of the reasons why risk management is so important:
- According to the CEO of Fyers, 90% of traders lose 90% of their trading capital in the first 90 days. You will not be among the 90% of traders if you use a sound risk management approach in your trading.
- Capital preservation is more vital than capital growth, which is where Risk Management may help.
- It’s risk management that rookie traders lack, and they risk all of their money on a single trade with a massive, deep stop loss.
Now that you understand what risk management is and why it is important, let’s move on to the next stage in putting it into practise.
How Can You Effectively Manage Your Risk?
Because of their lackadaisical approach, most newbies always blow off their accounts and then blame the market. So, if you’re a novice, or even if you know someone who is, here’s how to manage your risk effectively:
Set A Reasonable Stop-Loss
Suppose you entered a shorting position. You considered your stop loss to be the underlying security’s Resistance level. Let’s say you decide to position your stop loss at the previous swing high/low. While thinking of the level as resistance may be fair, the chances of the price going over that level are slim. However, you do not have to set your stop loss at the same levels. Why is it the case? Because all of the market’s colossal whales are aware that the exact level will have a plethora of stop losses. And you already know how much operators enjoy eating stop losses. As a result, always set your stop loss a few points above or below the point where you want to exit the trade.
Overtrading to make up for losses should be avoided at all costs.
Beginners frequently hit their stop loss and, rather than remaining away from the markets, attempt revenge trading. Why do people behave in this manner? They believe that by ending the day at breakeven or a stop loss, they will be able to exit the market with no profit and no loss. However, they are frequently incorrect. What do you mean by that? They end up trading with their emotions, which causes them to lose money.
If you know someone who would do this, or if you try to do it yourself, you should put a stop to it.
Remember the 1% rule in a 2% world…!!
The 1 percent in 2 percent rule should always be followed when trading. So, what exactly does this regulation imply? It’s straightforward; the rule consists of two easy-to-follow steps:
1 percent per trade risk
When you’re about to start a trade as a newbie, just decide that you won’t risk more than 1% of your whole capital in a single transaction.
2 percent daily total risk
When traders enter the markets, they should set aside a certain percentage of their cash to risk if their day goes bad. A trader should only risk 2% of their capital per day, as this will allow the capital to last for more than a hundred days.
Take Profit Points, like Stop Loss Points, should be included in the system.
Greed gets in the way of effective risk management.
People frequently believe that they can sell at a better price or buy at a lesser price. The price has dropped out of the range in minutes, harming their unrealized earnings. This isn’t a novel behaviour; it’s just basic human psychology. The human mind believes that whatever it has obtained is insufficient and that it may obtain more. To gain more, it must give up what it already has.
Take profit orders, like stop-loss orders, should be in your trading strategy while trading in the live market. Set your take profit orders at the price you choose, just like you set your stop loss using Stop Loss Market orders. This removes the greed and emotional factors from trading, allowing traders to concentrate on systematic and level-based trading.
Hedge Positions is a skill that can be learned.
Hedging is another part of risk management. In addition, the term “hedge” signifies “to guard.” As a result, someone who understands how to hedge their transactions automatically reduces the risk involved in trading.
What is the definition of hedging?
Let’s imagine someone is long in cash on Bajaj Finance and is trading positionally. If there is a drop in the market before their aim is met, they will lose their money. Instead of taking a loss, they tend to buy the BAJFIN Put Option or short sell the BAJFIN Call Option. Even if there is a minor market correction, this will keep them protected. Assume someone buys a Put Option on one of our indices, and they have even the tiniest amount of price reversal.
The preceding essay educated you on what Risk Management is and how traders can properly manage their risk.