Risk management tends to reduce losses. It could also effectively safeguard a trader’s account from losing all their assets. There is a possibility when the trader takes a loss. If it can be handled, the trader can open himself up to make money on the market.
It is an important, but often ignored, prerequisite for effective active trading. After all, a trader who has generated significant profits will lose all of this in only one or two bad transactions without a proper risk management strategy. So how do you develop the right strategies to reduce market risks?
This article highlights several basic techniques that can be used to secure your trading income.
Plan your trade: Planning and strategizing a trade is the most important aspect of day trading. Stop-loss and take-profit points are two main ways traders can prepare ahead while trading. Effective traders know what price they’re willing to pay, and what price they’re willing to sell. They will then calculate the resulting returns against the likelihood that the stock will meet its targets. If the modified return is high enough, the trade is carried out.
The iconic 1% rule: A lot of day traders follow the one-percent principle. Apparently, this rule of thumb implies that you can never position more than 1% of your capital or your trading account in a sole transaction So if you have $11,000 in your trading account, your position in any given instrument should not be more than $110.
This technique is popular to traders who have balances of less than $100,000 — some even go as high as 2% if they can handle it. Most traders whose accounts have higher balances can opt to have a lower percentage. That’s because as the size of your account increases, so does the position. The only way to hold your losses in check is to keep the rule below 2% — any higher, and you will lose a significant amount of your trading account.
Establishing Stop-Loss and Target-Price points: The price at which a trader will sell a stock and take a loss on the trade is known as the stop-loss point. If a trade does not go as expected, this is a normal occurrence. The points are intended to avoid the “it’ll come back” mindset and to keep losses from plummeting out of reach. When a stock falls below the main support level, for example, traders often sell as soon as possible.
A take-profit point, on the other hand, is the price at which a trader can sell a stock and profit from the transaction. When the additional upside is constrained by the risks, this is the case. For instance, if a stock is approaching the main resistance level following a significant upward step, traders may want to sell before a period of consolidation occurs.
Here are some key factors to bear in mind when deciding these points:
- For more volatile stocks, use longer-term moving averages to reduce the risk of a trivial price swing triggering a stop-loss order.
- To fit target price points, change the moving averages. Longer targets, for example, utilize larger moving averages to minimize the number of signals generated.
- Stop losses should not be less than 1.5 times the existing high-to-low range because they are more likely to be executed arbitrarily.
- The stop loss should be changed depending on the market’s volatility. Stop-loss points can be tightened if the stock price isn’t moving too far.
Assessing the Expected Return: Setting the stop-loss and take-profit points is also important to determine the expected return. This calculation’s significance cannot be overlooked, since it allows traders to think about and rationalize their trades. It also helps them to compare different trades in a structured manner and pick only the most lucrative ones.
Diversification: Being sure you make the most out of your trading means never putting your berries in one basket. If you place all your money in one stock or one instrument, you’re going to make a huge loss. So remember to diversify your investments — through the sector, market capitalization, and geographic regions. Not only does this help you control your risk, but it also opens up more doors for you.
Traders should always know whether they intend to enter or exit a transaction before they do so. By effectively using stop losses, a trader can minimize not only losses but also the number of times a transaction has become unnecessary. In conclusion, make your battle plan ahead of time, so you’ll know you won the fight.
Disclaimer: There are potential risks relating to trading and investing and you should not trade with money that you cannot afford to lose however, for those that educate themselves and adopt appropriate risk management strategies, the potential update can be significant. Please note that all opinions, research, analysis, and other information are provided as general market commentary and not as specific investment advice.
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