Risk Management In Trading
The first top quality skill needed to become an amazing trader is discipline, the second-best thing required is Risk management. Risk Management can be mentioned as the Heart of trading. Without Risk management traders cannot sustain in stock market. In every lost story in stock market, we have heard about a trader who has lost all his capital in trading. This happens every-time because of poor risk management. An intelligent and educated trader will take only calculated risk and will never put his total capital value at risk. As an intelligent trader we must execute trades with low risk and a decent reward. SEBI recently reported that the retail participation in Indian market is strongly going down.
Bull market brings in huge euphoria in the market along with new traders. Newbie traders will also be rewarded by the bull market phase as the price of the securities will keep moving up and up. After the bull market is over, newbie traders will find difficulty in generating income from market without risk management and proper market knowledge. Let’s understand every risk management technique and logic behind them to become a profitable trader in stock market.
How To Manage Risks in Trading?
Taking Calculated Risk
A common mistake traders make in the market is prioritizing calculating profits rather than calculating the maximum risk associated with a trade. Setting and calculating stop loss in mind is also an uncontrollable risk for positional traders. Gap up and Gap downs can bring unexpected losses than calculated losses for a trader. So, it’s very prominent for positional traders to calculate the actual value at risk than keeping a stop loss in mind. Newbie traders are advised to stay and trade only in equity market until having a great risk management and market knowledge. Trading in derivate market without proper knowledge can cause huge losses for traders. In derivative market, Option buying has limited risk only but option selling has unlimited risk that traders will end up losing their capital and must bring in additional capital to settle extra losses. So, the key takeaway is to acquire proper understanding and knowledge before making a move in the stock market.
Risk assessment and Risk appetite of a trader is depended on trading style, financial stability and life stage of a trader. Traders who follow intraday trading style can keep up with stop loss without any associated uncontrollable risk as there are no overnight positions. When it comes to positional trading in equity and derivative markets, decisive news and events about a stock or index can cause huge volatility and movement in the market. Positional traders will be hugely impacted by overnight positions. Risk is limited for positional traders in the equity segment. So, market players with less experience and market knowledge are advised to stay away from derivative markets.
Realistic Risk Reward Ratio
Calculating the risk involved in a trade is as important as calculating the profit of a trade. Having a trading system with a good risk reward ratio helps the trader to trade with discipline and can earn consistent income from the market. Risk reward ratio promotes the trader to calculate the stop loss level and target before entering a trade. It is relevant for traders to follow the risk reward system with discipline to generate income from the market. It’s prominent for traders to keep emotions away from the market and trust their trading system.
Risk Management Techniques Used In Financial Market
The most powerful risk management tool in the market is Stop loss. Traders can either place a stop loss at the entry time of the trade or can place a stop loss manually according to the risk management of the trader. Utilizing stop loss is the most effective way to mitigate losses in stock market. A stop loss order helps the trader to limit his risk automatically. A stop loss order will automatically exit the trade at a pre-determined price, this helps the trader to limit the downside risk in a trade and protect the capital from huge losses.
Proper position sizing along with a stop loss can minimize trading risk to a huge extent. Deciding the actual position size required for a trade is very relevant for effective risk management. Position sizing is about allocating the portion of total capital on a trade understanding the risk level of a trade.
With leveraged positions experienced traders can manage their risk to a great extent. Traders can use leverage to make intelligent trading decisions in the market. Traders can use leverage positions to reduce their risk reward ratio to achieve targeted returns. By utilizing the leverage, traders can achieve the target by reducing the price target. Huge risks are also associated with leveraged positions if a trader aims for higher profit with poor risk management. So new investors are advised to keep away from leveraged positions in the market.
Hedging strategy is one of the vital risk management tools used by investors and traders to avoid huge losses in stock market. Hedging helps traders and investors to brace the invested capital from a market crash and uncertain events or movements in the market. Investors use hedging instruments like futures and options to protect the investment portfolio from any kind of market uncertainty. Also, derivative traders like option sellers enters a trade with unlimited risk, giving proper hedges helps option sellers to minimize their risks and reduce the margin or capital required for entering a trade
Technical analysis is the key reason behind the success of a profitable trader. Technical analysis plays a prominent role in reducing risk by enabling traders to make informed decisions in the stock market. Price action analysis helps the traders to understand the support and resistance of an asset. Traders can easily manage their risk according to the positions. For example, if a stock breaks an important support, traders can book their losses early. Technical analysis helps to improve the risk management of a trader.
Proper risk management is the golden strategy to preserve capital and attain success in trading. Risk management requires great discipline, and you must keep trusting the trading system, keeping emotions away. You can also become a successful trader in the market if you have a good enough trading system and robust risk management. Also, if you are a new trader keep your focus on learning, that will help you become an amazing trader.