The work of risk management is to balance the opportunities for gain with the possibility of losses. This can reduce losses and increase profits. This work can also protect traders from losing their entire money. When traders open positions, they run the risk of losing their money. The risk is greater, but the potential for profit is greater, as well.

Risk management is a prerequisite for successful active trading, but it’s often forgotten. A trader can lose all of his profits in one or two bad deals without having a good risk management strategy. How can you learn to reduce the risk of the market with the best possible techniques?

This article will provide you with some simple strategies to help protect your trading profit.

Key Takeaways

• Trading can be fun and profitable if you stay focused and do your due diligence.
• Even the best traders must incorporate risk management techniques to avoid losses getting out of hand.
• It is smart to use stop orders, profit-taking, and protective put to cut losses.

Planning Your Trades

Sun Tzu, the Chinese general of military fame, famously stated, “Every battle has already been won before it’s fought.” This phrase implies that planning and strategy, not battles, win wars. Successful traders often use the phrase, “Plan the trade, and trade the plan.” Planning is important in business, just as it is during war.

Be sure that your broker can handle frequent trading. Some brokers cater to customers who rarely trade. Some brokers charge high commissions and do not provide the analytical tools that active traders need.

Two key planning tools for traders are the stop-loss and take-profit points. Successful traders are able to determine what they will pay for a stock and what they are willing to sell it at. Then, they can compare the returns to the likelihood that the stock will reach its goal. They execute the trade if the adjusted return is sufficiently high.

In contrast, inexperienced traders will often make a trade with no idea at what point they’ll sell for a profit. Emotions can dictate trades, just as they do for gamblers who are on a streak of good luck or bad. Losses can cause people to hang on in the hope of recovering their losses, whereas profits can encourage traders to continue to trade for more gains.

Consider the One Percent Rule

Many day traders adhere to the “one-percent rule”. This rule of thumb basically says that you shouldn’t invest more than 1% in a single transaction. If you have $10,000 in your trading account, the maximum position that can be held in any one instrument is $100.

Some traders even choose to go up to 2% if they are able. Some traders with higher account balances decide to use a lower percentage. This is because your position increases as your account grows. Keep your losses under 2%. Any more than that, you risk a significant amount of your trading accounts.

Set Stop-Loss Points and Take Profit Points

Stop-loss points are the prices at which traders will sell stocks and incur a loss. This is often the case when a trade doesn’t go as planned. These points are intended to limit losses and prevent traders from adopting the mentality that “it will return”. Traders will often sell a stock as soon as it breaks below an important support level.

A take-profit price is the price at which a trader sells a stock to make a profit. The additional upside will be limited if the risk is high. If a stock has made a big upward move and is now approaching a key level of resistance, traders might want to sell the stock before there is a period for consolidation.

How To Set Stop Loss Points

Technical analysis is used to set stop-loss points and take-profit levels, but fundamental analysis also plays a role. If a trader holds a stock before earnings and excitement is building, they might want to sell it before the news hits, even if the take-profit has been reached.

The most popular method of setting these points is to use moving averages. They are easy to calculate, and the market tracks them closely. The key moving averages are the 5, 9, 20, 50, 100, and 200-day averages. The best way to determine these is to apply them to the chart of a stock and see if the price has responded to them as a resistance or support level in the past.

Support or resistance trendlines are another great place to put stop-loss and take-profit levels. You can draw these by connecting highs and lows from the past that were on a significant volume. It is important to determine the levels where the price reacts with the trendlines or moving averages and, of course, on high volume.

Here are some important considerations to keep in mind when setting these points:

• For volatile stocks, use longer-term moving averages to reduce the risk that a meaningless swing in price will trigger an order to execute a stop loss.
• Adjust moving averages according to target price ranges. Larger moving averages should be used for longer targets to reduce the number generated by signals.
• Stop losses shouldn’t be less than 1.5 times the current range of high to low (volatility) as they are likely to be executed without cause.
• The stop-loss points can be adjusted according to market volatility. If the stock price doesn’t move too much, the stop-loss levels can be tightened.
• As volatility and uncertainty may increase, use known fundamental events like earnings releases as key times to enter or exit a trade.

Calculating expected return

Calculating the expected return also requires setting stop-loss points and take-profit levels. This calculation is crucial because it forces traders to think about their trades. This method allows them to compare different trades in a systematic manner and select only the most profitable ones.

You can calculate this using the formula:

[Probability Of Gain) x [Take Profit % Gain] + [Probability Of Loss] x [Stop Loss % Loss]

This calculation will give the active trader an estimated return, which he can then compare to other trading opportunities to decide what stocks to buy. Calculating the probability of a gain or loss is possible by using historical breakouts or breakdowns from support or resistance levels or, for experienced traders, by making an educated guess.

Diversify your hedge

Never put all your eggs into one basket if you want to make the most out of your trading. You’re setting yourself up for a major loss if you invest all your money in one idea. Diversify your investments across industry sectors, market capitalizations and geographical regions. This will not only help you to manage your risks but also give you more opportunities.

You may also need to hedge your position. When results are due, consider a stock. Consider taking a position in the opposite direction through options. This can protect your position. You can unwind your hedge when trading activity slows down.

Downside put Options

You can use a downside put, also known as a protection put, to hedge against losses in a trade if it goes south. Put options give you the right to sell underlying stocks at a specific price at or before the expiration of the option. If you buy the $80 six-month put option for $1.00 in premium and own XYZ for $100, you are effectively blocked from any price drops below $79 (80 strikes minus $1 premium).

What is Active Trading?

Active trading is the act of regularly trying to profit from short-term fluctuations in price. Stocks are not bought for retirement. The aim is to hold the stocks for a short period and then try to make money from the current trend. The term active traders is used to describe traders who are constantly in and out of the market.

What are the risk management techniques used by active traders?

Active traders manage their risk by finding the right broker and thinking before they act. They also set stop-loss points and take-profit levels, spread bets, diversify, and hedge.

What is the 1% rule in trading?

The 1% Rule states that traders should never invest more than 1% of their account total in a single transaction. This does not mean that you can only invest 100 dollars in a $10,000 account. You shouldn’t be able to lose more than 100 dollars on one trade.

What is the best way to become a successful active trader?

You must be able to understand the financial markets, and you should also know how to use various tools for reading price movements. You also need to have enough capital and time for trading and the ability to keep your emotions under control. It is important to have a plan and stick with it. If you want to succeed over the long term, spread out your bets.

Active trading may not be for everyone. Contrary to what you might hear, active trading is not easy or guaranteed to make you enough money to quit your job. Start small and simulate some trades before you put your money at risk.

The Bottom Line

Before they execute, traders should know exactly when they intend to enter or exit the trade. Stop losses can be used to minimize losses and the number of trades that are exited without reason. Make a battle plan and record your wins and losers.

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