Reducing losses is facilitated by risk management. Additionally, it can aid in preventing traders’ accounts from losing their whole balance. Losses for traders represent a risk. Traders can increase their chances of success in the market if they can control their risk.
It is a necessary but sometimes disregarded precondition for profitable active trading. After all, without an effective risk management plan, a trader who has made significant profits could lose it all in one or two poor deals. So, how do you create the most effective strategies to reduce market risks?
In this article, we’ll talk about a few easy tactics to safeguard your trading earnings.
1. Organizing Your Trade
In the words of the renowned Chinese military commander Sun Tzu, “Every battle is won before it is fought.” This expression suggests that strategy and preparation, not combat, win wars. Likewise, successful traders frequently use the adage, “Plan the trade and trade the plan.” Like warfare, forethought can often spell the difference between victory and defeat.
Make sure your broker is appropriate for regular trading first. Certain brokers cater to customers who trade seldom. They don’t provide aggressive traders with the necessary analytical tools and charge exorbitant commissions.
Take-profit (T/P) and stop-loss (S/L) points are two essential tools traders can use to prepare ahead while trading. Proficient traders are aware of their willingness to buy and sell at different prices. They can then compare the likelihood that the stock will achieve its objectives with the ensuing returns. They carry out the transaction if the adjusted return is sufficiently high.
On the other hand, losing traders frequently enter a transaction without knowing when they will sell for a profit or a loss. Similar to speculators riding a profitable—or unprofitable—streak, feelings start to control and direct their trades. Profits might tempt traders to foolishly hang on for even more significant gains, while losses frequently prompt people to hang on and try to get their money back.
2. Examine the Rule of One Percent
Many day traders adhere to the so-called one-percent rule. Essentially, this general guideline advises against investing more than 1% of your trading account’s value or money in a single transaction. Consequently, your position in any particular instrument shouldn’t exceed $100 if you have $10,000 in your trading account.
This is a typical approach for traders with accounts under $100,000; if funds permit, some traders use as much as 2%. Many traders with larger account balances might decide to use a smaller percentage. This is due to the fact that the position grows together with the amount of your account. The rule should be kept at 2% as this is the best approach to limit your losses; if it is higher, you will be losing a significant portion of your trading account.
3. Determining Take-Profit and Stop-Loss Points
The price at which a trader will sell a stock and incur a loss on the transaction is known as the stop-loss point. This frequently occurs when a trade does not turn out as the trader had anticipated. The points are intended to stop people from thinking that “it will come back” and to stop losses before they get out of hand. For example, traders typically sell as soon as a stock breaks below a critical support level.
A trader’s take-profit point, on the other hand, is the stock price at which they will sell and turn a profit on the transaction. At this point, the additional upside is constrained by the associated dangers. For instance, investors would wish to sell a stock before a period of consolidation occurs if it is getting close to a significant resistance level following a significant upward rise.
4. Estimated Return Calculation
To compute the predicted return, stop-loss and take-profit points must also be set. It is impossible to overestimate the significance of this computation since it compels traders to consider and justify their trades. Additionally, it provides them with a methodical manner to evaluate several transactions and choose only the most lucrative ones.
The formula below can be used to compute this:
[(Probability of Gain) x (Take Profit % Gain)] + [(Probability of Loss) x (Stop-Loss % Loss)]
This computation gives the active trader an expected return, which they can compare to other possibilities to decide which stocks to trade. Experienced traders can estimate the likelihood of profit or loss by examining past breakouts and breakdowns from the support and resistance levels or by speculating.
5. Vary and Contain
Never put all your eggs in one basket to maximize your trade. You’re inviting yourself to a significant loss if you invest all your money in one concept. Never forget to diversify your investments across market capitalization, geographic location, and industrial sectors. This allows you to take advantage of more chances while also assisting you in managing your risk.
Additionally, you might need to hedge your position. When the findings are expected, think about taking a stock position. To strengthen your position and preserve your viewpoint, you may think about using choices to take the opposing stance. It is then possible to unwind the hedge when trade activity declines.
6. Negative Carry Options
Purchasing a downside put option, commonly referred to as a protective put if you are permitted to trade options, can also be used as a hedge to reduce losses from a trade that goes bad. With a put option, you have the choice—but not the duty—to sell the underlying stock at a predetermined price at or before the option’s expiration date. Thus, if you purchase a six-month $80 put option for $1.00 per option in premium and own $100 worth of XYZ stock, you will essentially be stopped from any price decline below $79 ($80 strike less the $1 premium paid).
In the end!
Before they execute, traders should always have a plan for when to enter or exit a trade. A trader can reduce unnecessarily existing trades and their losses by employing stop losses strategically. Finally, prepare your strategy in advance and record your victories and defeats in a notebook.
