Traders that have been successful over the longer term, realize that avoiding big losses is just as important as or even more important than finding profitable trades. The key concepts related to risk management traders that are successful over the long term also tend to have successful risk management techniques. They are quick to cut losses on trades and move on to greener pastures. They trade small initially when entering a new market in order to gain experience. They trade where the odds favor success and avoid marginal trades. They take a diversified approach to trading and they’re more focused on exiting a trade then entering a trade.
The key to all of this and the common goal is to maintain and preserve capital for the long term and minimize the impact of trading losses on your capital base. Large losses on an individual trade can be devastating for a trading portfolio following a 10 percent loss. It takes an 11 percent return just to get back to where you started on a 20 percent loss you need to make a25 percent return. Just to get back to the beginning and a 50 percent loss you need to double your money on your remaining capital just to get back to where you were.
There are a number of ways that traders manage their risks through the whole trading process:
First of all, they look at risk in terms of their overall portfolio and capital base risk management techniques are also used in selecting which trades to put on and also once a trade is actually underway risk is managed as well.
The Portfolio Level
One way that successful traders use to manage their risk is to limit the amount of capital that they put in any one trade. For example perhaps five percent of their total capital they also make sure that when having more than one trade active that they’re in different markets to help diversify.
In addition, successful traders tend to trade one merging trends rather than ones that had been in place for a long time and are subject to reversal. There are also a number of techniques to manage risk in trades once the trade is actually underway.
First of all, a position can be divided into units whereby some units are held for the longer term and some are used to try and capture shorter-term movements. A position can also be divided into units where you start with a partial position and then add to the position. If the trade starts to go your way on the flip side stop losses can also be used to help you get out of the position should it go against you?
As successful trades emerge, traders tend to move up they are stops behind the market in order to help them capture profits as time goes on this is known as implementing trailing stops. Trailing stops can come into fashions first is a fixed monetary amount behind the market or a fixed percentage amount.
Transaction-based are stop loses are a new risk management tool that can help you to stop from losing more than your initial deposit. When you enter an order the transaction based on the stop-loss system will recommend a stop-loss that is equal to preserve your minimum margin requirement this way should the trade go against you. You can be automatically taken out before you get a margin call and having to worry about what to do then.
Traditionally when choosing which type of order to place, traders have had to consider the trade-off between price and execution. Market orders can be filled very quickly but in fast-moving markets, you may have to give on the price. On the other hand limit orders, you get to set your price but you may not necessarily be filled. Boundary orders are an attempt to bridge the gap between the two they enable you to set a range of prices that you are willing to be executed on but to exclude markets that move too far against you.