Risk Management Techniques for Active Traders | My Espresso

Risk Management Trading Techniques

Trading comes with both returns and risks. The equilibrium between these two facets resembles your trading approach and success. However, it’s also the center of the problem. The first thing that revolves around the mind of an amateur trader is the amount they can earn from a trade.

Well, this attitude won’t help you. Instead, you should think about how much you can lose from the trade. By leveraging trading risk management, you can increase and multiply your potential revenues while lowering your probable losses.

Published on 05 January 2023

In this article, you’ll learn what trading risk management is, the various risk management techniques, and more. So, read till the end.

What is Trading Risk Management?

Trading risk management in the finance sector implies the procedure of detecting, assessing, and eliminating the risk of losses while investing. The risk of incurring loss haunts many active traders who don’t know how to manage them.

These losses actually occur when the stock market shifts in an opposed way to the trader’s prediction and expectations. Market trends are developed by the trader’s risk emotion, which numerous factors can determine.

These factors are basically business events like new technology, economic events like revised interest rate decisions, and political events like elections.

Trading Risk Management: How To Do It?

The ideal solution to risk management for trading is determining as many risk-associated factors as possible that can impact your portfolio condition before you even start trading.

You cannot overemphasize this fact too. By observing and marking every potential vulnerability and risk to your investments, you’ll be done with your homework on what can possibly go against your expectations. Consequently, you can devise your own backup plan.

Having an idea of how to respond and act in such circumstances will assist you in keeping your cool and controlling your emotions even if the situation calls for anger. This will boost your confidence to know that your risk management strategy relies on in-depth research and precisely tested data.

Know The Various Trading Risk Management Tools

Some crucial aspects of trading risk management comprise stop losses, profit takers, trade size, the 1% rule, stop loss placement, and risk-reward ratios. So, let’s take a better look at some of these aspects:

The 1% Rule

Successful active traders and investors avoid risking anything that exceeds 1% or 2% of their trading account value. So, let’s say you have $10,000 in your trading account, and you’re ready to risk 1%-2% of this amount. In that case, you’ll only risk $100 or $200 for a single trade.

These small risks will not empty your account, even if you face any loss. Going for any extra risk can hinder your long-term success and profits. Being a good active trader means having the discipline and making calm, rational decisions.

Take Profit & Stop Loss

A stop loss stands out as an effective tool when it comes to trading risk management. It is an order that exits the trade whenever the stock market price shifts or surpasses a pre-selected level.

Traders leverage a stop loss to determine how much risk they can bear and assists you in setting a pre-determined risk/reward ratio. This will let you know the amount that you could possibly win or lose in advance.

Take profit decides which will exit or close the trade deal at the point of profit. The limit order is typically positioned above the trade price when you are long a market.

However, the limit order will be placed underneath the trade price when you are short a market. The ideal way to determine where to put the profit taker is by leveraging the market structure.

Risk Reward Ratio

You must know that establishing a decent risk-reward ratio is crucial. Once you know the place where you’ll put the Take Profit and Stop Loss, you can think about the risk-reward ratio for that position.

The general rule of thumb is that successful active traders will never go for traders with a risk-reward ratio of less than 1:2. Some traders only opt for trades with a risk-reward ratio of 1:3.

It implies that the potential reward from a successful trade must be a minimum double (1:2) the expected risk. In the long run, this rule helps the trader avoid overtrading. 

Ending Note

Trading risk management is highly beneficial for active and novice traders. It helps them know when to enter and when to exit a trade. Using these risk management tools effectively can minimize the number of losses and maximize their profit earnings.

Chandresh Khona
Team Espresso

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