Risk management, methodology, and mental control are the three most important factors in trading. Without risk management, no matter how good your trading strategy is or how strong your mentality is, you will not be successful in trading.
In this article, you will learn tips from a professional's approach to risk management.
1. Is the expected profit worth the risk?
Trading is about taking risks in the pursuit of profits. Mastering a trading technique alone will not lead to long-term gains. First, consider whether the trade is worth the risk and do you have a " trading edge." A good rule of thumb is to calculate the risk-reward ratio (average profit/average loss). If your target is smaller than your stop loss, making long-term profits trading forex will be challenging. Rather than focusing only on achieving a high win percentage, consider achieving a risk-reward ratio as well.
2. Adapt trading strategy to volatility changes
When the market moves more than usual, the possibility of your stop order being hit increases, so the stop loss should be increased. However, simply widening the stop can be problematic for risk management. An increase in volatility will also require an increase in target and potentially a smaller position size. On the other hand, when the market is quiet, targets are harder to reach, so targets and stops should be smaller, and position sizes should be larger to remain profitable.
3. Win rate and risk reward ratio are linked
You must calculate your risk-reward ratio and understand what percentage of your winning trades you need to win to be profitable long-term. For example, if you risk more than five times as much as your winning trades, you will lose even if you have an 80% win rate.
4 Focus on long-term results
Placing too much importance on the result of one trade can negatively affect your trading performance. At the end of the day or weekend, reviewing the results of your trades to see if you followed the rules is far more important than making money today. Following risk management rules is the difference between trading and gambling.
5. Be aware of trading fees
When the market moves, we get so absorbed in the price action that we forget that we are incurring commissions and spreads each time we trade. The more trades you make, your trading costs will inevitably be higher. As a result, over-trading makes it challenging to earn long-term profits.
6. Focus on a small number of markets
There are many different markets to trade, but it usually pays to become an expert in a small number of markets. However, having positions in many markets means taking on a lot of risk. Therefore, instead of increasing the number of markets, trading larger positions in a few markets is advisable. Do not try to make up losses in one market by trying to make up losses in another market.
7. Prevent profits from turning into losses.
If a position you hold is approaching a target but reverses just before the profit target, reduce your stop to break even. Seeing a profitable trade turn into a loss can be stressful, and it is tempting to revenge trade. In such a state, calm judgment becomes difficult. Therefore, reduce your stop level as your trade becomes profitable to prevent your position from turning into a loss.