Every trader should know how to use technical and fundamental analysis. However, this knowledge is not enough to become a professional trader.
To perform profitable deals, traders should master their capital management skills. In other words, they should control their risks and money.
The key idea of capital management is to increase profits whereas risk management is aimed at reducing losses. In this chapter, we will discuss each aspect in detail.
Your success in trading highly depends on risk control.
You should start using loss reduction strategies, which will help you perform successful deals even in case of unexpected losses.
All deals involve some degree of risk.
General principles of risk management will help you minimize possible losses. Below, you can see several methods of controlling losses. They can be applied by both beginning and experienced traders.
Do not neglect to prepare for trading
You should not underestimate preparation for trading. Before risking your money, make sure that you are opening the right deal. Besides, it is important to understand what financial risks you may face. Thus, before opening a deal, forecast potential losses in case the market moves against you by 5%, 10%, or 20%. It’s better to calculate the biggest losses. You will succeed in risk reduction if you perform only those deals that you have effectively analyzed.
Develop and follow your own plan of trading.
Every trader should have an individual method of trading. Traders’ behavior can be based on fundamental factors or technical indicators, or on both. As usual, traders try out and modify their methods as many times as necessary until they get positive and permanent results. Before risking your money, make sure that you have developed a reasonable approach that will bring you profit. The most important thing is to decide what sum you can lose. As soon as you reach the sum, close your position. Closely follow your method and avoid impulsive behavior.
If you do not stick to your plan, then you do not have it.
A carefully considered plan can help find out the main factors that influence your deals. Besides, the plan can be used to avoid mistakes in future deals. Moreover, it will give you confidence and prevent you from rash decisions. But do not follow your plan blindly. If you do not understand the market situation or you are getting too emotional, it is better to close positions. Do not rely on market rumors or recommendations. In general, make thorough preparation and consider possible variants of deal development before starting trading.
Use diversification..
You can minimize your risk diversifying your portfolio. There is no necessity to invest all money in one deal. Diversify your risks using only 5% or 10% of your funds to open a deal. To achieve the goal, you should be sure that the diversified portfolio includes the instruments the correlation of which you know well. (Correlation is a price movement of particular instruments at the same period of time).
If you open a long position on EUR/USD and a short position on USD/CHF, you actually have only one position. The fact is that these instruments are highly correlated (their price movements are very much alike). Thus, you have only one position but with a double risk. In reality, it is the same if you open two positions on one of these instruments. You should always control relation between all your positions, keep portfolio balanced and adjust it. Stop orders reduce risks and losses that you can face trading on highly volatile markets.
Do not invest all money you have.
First of all, make certain that you have enough money to compensate for unexpected losses. If you have an impression that a particular deal is very attractive and has a chance of becoming profitable, it is better to stop and think everything over. The first impression can be wrong as market conditions are seldom favorable. In case the market changes its direction, for example, to a downtrend, it is recommended to have a particular sum of money to compensate for losses or deposit additional funds to meet the margin requirement. Additional money can help you avoid stress and additional risk.
Use stop orders
Stop orders reduce risks and losses when you trade in volatile markets. To achieve success, follow the rule: leave the market if your losses hit 5%-7%. Even professional traders set stop orders to limit risks. You should also close positions if your plan turned out to be false. Do not neglect stop orders at the beginning of your trading career because they can protect you when you really need it. If the market does not meet your expectations, leave it even if you still have all your money. There are traders who prefer time stop orders. In difficult or unclear situations, time stops remind you to leave the market.
Follow the trend.
If you follow the trend, you will hardly face losses. If you follow a particular trend, market direction is not that important. If you have opened a losing deal, it’s better to reduce the risk size gradually.
Be ready for mistakes and learn to face losses.
It is very important to admit mistakes and close deals even if you can lose money. Experienced traders also suffer losses from time to time. Nobody likes admitting failures thus it can be rather difficult to follow this rule. In fact, you should increase profit and reduce losses. If you open a deal against a particular trend, do not add to the losing position hoping to compensate for losses. If you do not understand the current market situation, close the deal. It is better not to open a new order as you need to calm down.
Trade safely.
“The most important rule is to play great defense, not great offense,” one of famous traders said. First of all, you should compare your possible losses with your possible gains. Secondly, get ready to the worst scenario. Remember that the market can change its direction at any moment. Besides, you should know the maximum leverage available for your account type. Adjust stop orders if necessary. You should also have a plan to leave the market. Thus, you are ready to meet problems.
Avoid excessive trading.
To limit risks, reduce a number of deals and keep small bets. You should fully understand the risk that you may take. Open only one deal to have time to think over scenarios. As a result, you will have almost no chances to perform impulsively. You can concentrate on only one deal. Besides, commission charged by a broker will be smaller.
Control your emotions.
Every trader has suffered losses and great stress. Unfortunately, it is impossible to avoid such situations when trading in the market. Anxiety, frustration, depression, and sometimes despair are so-called side effects of professional trading. You should control your emotions to avoid their influence on trading. Rely only on rational and well considered decisions. You can communicate with other traders and share your experience and problems.
If you have any doubts, better close positions.
If you have doubts concerning your success, it means that your plan needs adjustments.
Leave the market in the following situations:
Market behavior is irrational;
You are confident about profitability of the deal;
You do not know what to do.
You can risk your money, only if you are sure of what you are doing.
To perform profitable deals, traders should master their capital management skills. In other words, they should control their risks and money.
The key idea of capital management is to increase profits whereas risk management is aimed at reducing losses. In this chapter, we will discuss each aspect in detail.
Your success in trading highly depends on risk control.
You should start using loss reduction strategies, which will help you perform successful deals even in case of unexpected losses.
All deals involve some degree of risk.
General principles of risk management will help you minimize possible losses. Below, you can see several methods of controlling losses. They can be applied by both beginning and experienced traders.
Do not neglect to prepare for trading
You should not underestimate preparation for trading. Before risking your money, make sure that you are opening the right deal. Besides, it is important to understand what financial risks you may face. Thus, before opening a deal, forecast potential losses in case the market moves against you by 5%, 10%, or 20%. It’s better to calculate the biggest losses. You will succeed in risk reduction if you perform only those deals that you have effectively analyzed.
Develop and follow your own plan of trading.
Every trader should have an individual method of trading. Traders’ behavior can be based on fundamental factors or technical indicators, or on both. As usual, traders try out and modify their methods as many times as necessary until they get positive and permanent results. Before risking your money, make sure that you have developed a reasonable approach that will bring you profit. The most important thing is to decide what sum you can lose. As soon as you reach the sum, close your position. Closely follow your method and avoid impulsive behavior.
If you do not stick to your plan, then you do not have it.
A carefully considered plan can help find out the main factors that influence your deals. Besides, the plan can be used to avoid mistakes in future deals. Moreover, it will give you confidence and prevent you from rash decisions. But do not follow your plan blindly. If you do not understand the market situation or you are getting too emotional, it is better to close positions. Do not rely on market rumors or recommendations. In general, make thorough preparation and consider possible variants of deal development before starting trading.
Use diversification..
You can minimize your risk diversifying your portfolio. There is no necessity to invest all money in one deal. Diversify your risks using only 5% or 10% of your funds to open a deal. To achieve the goal, you should be sure that the diversified portfolio includes the instruments the correlation of which you know well. (Correlation is a price movement of particular instruments at the same period of time).
If you open a long position on EUR/USD and a short position on USD/CHF, you actually have only one position. The fact is that these instruments are highly correlated (their price movements are very much alike). Thus, you have only one position but with a double risk. In reality, it is the same if you open two positions on one of these instruments. You should always control relation between all your positions, keep portfolio balanced and adjust it. Stop orders reduce risks and losses that you can face trading on highly volatile markets.
Do not invest all money you have.
First of all, make certain that you have enough money to compensate for unexpected losses. If you have an impression that a particular deal is very attractive and has a chance of becoming profitable, it is better to stop and think everything over. The first impression can be wrong as market conditions are seldom favorable. In case the market changes its direction, for example, to a downtrend, it is recommended to have a particular sum of money to compensate for losses or deposit additional funds to meet the margin requirement. Additional money can help you avoid stress and additional risk.
Use stop orders
Stop orders reduce risks and losses when you trade in volatile markets. To achieve success, follow the rule: leave the market if your losses hit 5%-7%. Even professional traders set stop orders to limit risks. You should also close positions if your plan turned out to be false. Do not neglect stop orders at the beginning of your trading career because they can protect you when you really need it. If the market does not meet your expectations, leave it even if you still have all your money. There are traders who prefer time stop orders. In difficult or unclear situations, time stops remind you to leave the market.
Follow the trend.
If you follow the trend, you will hardly face losses. If you follow a particular trend, market direction is not that important. If you have opened a losing deal, it’s better to reduce the risk size gradually.
Be ready for mistakes and learn to face losses.
It is very important to admit mistakes and close deals even if you can lose money. Experienced traders also suffer losses from time to time. Nobody likes admitting failures thus it can be rather difficult to follow this rule. In fact, you should increase profit and reduce losses. If you open a deal against a particular trend, do not add to the losing position hoping to compensate for losses. If you do not understand the current market situation, close the deal. It is better not to open a new order as you need to calm down.
Trade safely.
“The most important rule is to play great defense, not great offense,” one of famous traders said. First of all, you should compare your possible losses with your possible gains. Secondly, get ready to the worst scenario. Remember that the market can change its direction at any moment. Besides, you should know the maximum leverage available for your account type. Adjust stop orders if necessary. You should also have a plan to leave the market. Thus, you are ready to meet problems.
Avoid excessive trading.
To limit risks, reduce a number of deals and keep small bets. You should fully understand the risk that you may take. Open only one deal to have time to think over scenarios. As a result, you will have almost no chances to perform impulsively. You can concentrate on only one deal. Besides, commission charged by a broker will be smaller.
Control your emotions.
Every trader has suffered losses and great stress. Unfortunately, it is impossible to avoid such situations when trading in the market. Anxiety, frustration, depression, and sometimes despair are so-called side effects of professional trading. You should control your emotions to avoid their influence on trading. Rely only on rational and well considered decisions. You can communicate with other traders and share your experience and problems.
If you have any doubts, better close positions.
If you have doubts concerning your success, it means that your plan needs adjustments.
Leave the market in the following situations:
Market behavior is irrational;
You are confident about profitability of the deal;
You do not know what to do.
You can risk your money, only if you are sure of what you are doing.
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