Risk Management is the primary cause for a successful or unsuccessful
trading experience. A sound risk management can yield a steady
accumulation of profits, and increasing P&L, while a poor risk
management can wipe out an account in a very short period. Most novice
(and sometimes even more advanced) traders tend to make few critical
mistakes when it comes to risk management, mistakes that can easily be
identified, addressed, and rectified. In this article we will review the
common mistakes that we tend to repeat and should avoid.
Understanding Leverage
Leverage
is a key ingredient in trading. As we want to gain substantial returns,
we use leverage to increase our capital base. Leverage is basically a
loan that our broker gives us for trading purposes (a.k.a, trading
margin). Most Forex brokers use 1:200 leverage, which means that every 1
currency unit that we put, buys us 200 units for trading purpose (for
example : we deposit 10,000USD, which enables us to trade up to
2,000,000USD , or 20 lots in lot size). The leverage bears great risk,
if we don’t know how to use it wisely. A 1:200 leverage means that if we
utilize the maximum amount on one trade , and the trade loses 0.5%, we
will be asked by the broker to put more money to keep the position
opened (in other words, a “margin call”). As we can see the portion of
equity that we use will determine how much loss we can withstand before
we are forced to close a position. As much as it is tempting to trade
big amounts, the available equity needs to be taken into consideration
to avoid “margin calls”.
Analyze, Back-test and Arrive to Conclusions
People
tend to think that trading is what we see on the big screen, and TV
series about Wall St. and the hedge fund businesses. The truth of the
matter is that it is nothing like that. A large portion of the trader’s
day is dedicated to the footwork of trading such as; analysis of the
current positions, risk and possible scenarios that can jeopardies the
P&L. Also, it is vital to look at closed positions and understand
what we did right and what we did wrong (not in a sense of “I shouldn’t
buy/sell”, or “If only I had a crystal ball”, but rather “how could I
mitigate the risk in a more effective way”), and what we did right
(which is also very important to understand). Once we analyze the closed
trades and note the conclusions that arise from our analysis, we will
be able to avoid trading mistakes and repeating patterns of bad trading.
Most traders lack the use of powerful assistance of “paper trading”, as
they feel that it doesn’t get them anywhere in making money. But that
assumption could not be more wrong. Paper trading lets us experiment,
test new strategies, and get insights without bearing the risk. The way
we see it, trading is 80% analysis and 20% taking positions.
Preparation
People
devote too little time to building the strategies that they execute.
Some traders will trade based on a hunch, without taking serious time to
prepare, and come up with an exit strategies when they take positions.
Increasing the profitability of any trade involves careful preparation,
including various levels of analysis (whether it’s technical or
fundamental). Also, upon taking a position, a trader should know where
to place the stop-loss and take-profit orders. Although it’s tempting
not to place a stop-loss, it is essential to do so, as this will protect
us from significant losses, which can end up wiping out our fund, while
we need to define where we lock our profits. Furthermore, once we
define the stop-loss, we need to adjust the position size, such that we
will know, upon initiating the position, the maximum loss that we can
suffer (if the market goes against us). A good risk/reward
(stop-loss/take-profit) ratio should be 1:1.5 or above, meaning that if
we risk ourselves with 1% stop-loss, we should aim to take AT LEAST 1.5%
profit. As we can see, we should aim to trade only trades that meet
such minimum criteria, as this will ensure that in the long term we will
be profitable, despite stopping out on a position every now and then.
Don’t bite off more than you can chew
Sometimes,
traders tend to have unrealistic trading goals. We all want to be
wealthy, but we must set ourselves realistic goals, that will both meet
our risk appetite, and will be feasible to achieve. It is important that
we will risk only amounts that we will comfortable loosing (obviously
we don’t want to lose, but we need to assume the worst and see that we
can live with that). Once we set our daily target/ maximum loss, we
should stick to the target (or the maximum daily loss) and be
disciplined (meaning once we hit the target we should stop trading for
the day.
Source:
https://www.fxstreet.com/education/how-the-right-risk-management-can-save-you-from-trading-losses-201608151405
Add Your Comments