Importance of risk management in trading
Risk management is a key factor in becoming and continuing to be a successful trader, no matter which market you are trading in and how much money you are staking. With trading, losses are inevitably going to happen sometimes; so, managing risk and minimising these losses is vital.
Even a trader who has made substantial profits over a long period of time could just lose it all within one or two bad trades if they are not employing proper risk management, as it is vital, especially within volatile markets, that traders often operate within.
Risk can be defined as the probability of losing money or capital to trade with and in this context refers to the probability of having losing trades and therefore losing money.
It is true that the more risk you are willing to take, the greater is the reward potential; however, many inexperienced traders have taken this too far and it has been their downfall. If you don’t take enough risk though you will be limiting the amount of profit you could make, therefore it is key to have balance and employ risk management.
A simple method often used as a form of risk management is to have a stop loss. A trader is able to calculate in advance the maximum loss they are willing to take per trade they enter into, in the instance that the price moves in the opposite direction to what was hoped. This prevents any more loss of money and stops any large losses within a market that changes quickly. It is precisely for this reason all responsible trading and spread betting platforms, City Index being one example, offer a free stop loss tool to make use of.
A reward:risk is also a tool worth looking at, that is also relatively simple. It helps to measure risk vs reward and helps to predict how much profit could arise from a trade against how much you would be willing to lose. This is good for beginners to trading as you can set the amount in relation to what your personal trading goals are and available capital. It will help with stop orders and help minimize losses and increase earning potential.
Another way to manage risk is to simply have a diversified portfolio, with investments in different markets. A strong portfolio should be spread across a minimum of 5 different investments. This minimizes overall risk and exposure, meaning one bad investment decision will not affect your whole portfolio or wipe out all your capital.
Ultimately, the objective of risk management is to ensure that capital is used wisely, and profits are made, whilst minimizing any losses. Whether you are trading on the forex market, participating in any other form of spread betting, the stock market, options market or any other trading market; risk management is vital and must be a top priority for any trader to protect and grow their investments. Make sure you know what your personal tolerance for risk is and make sure you have a suitable risk management strategy to account for this. Don’t ever risk an amount of money you couldn’t afford to lose.
