Risk management lessonI mentioned it on another day already, but this topic is very important so I decided to share it again to reach as much as possible. Hope it will help some!
The last weeks it happend again, I saw some traders with less knowledge (young and old) who crashed their accounts very hard. They lost a lot of money and for some it was very dreadful!
It is hard to watch this people how they burn money and bring even his own family in financial danger. That´s why I decided to share one important chapter from my book here to you.
May be some will find very helpful, or some will remember this rules again.
I will keep it a bit shorter here as in my book, but the main points are still mentioned!
I can´t say it often enough, keep the important rules in trading. Trading is not the way to get rich quick, it is a serious and hard business! It take a lot of time to learn, it requires a lot of patience and it will happen a lot of failures.
This failures are even more important than your success! Success will not open up how it will not work, failures will.
Let´s talk about risk management!
For each investment you have to consider you take for each trade the risk to lose money, that´s why it is mandatory to handle each investment with a good risk/reward distribution.
You have to keep in mind, the determined risk/reward is only theoretically and can result complete different. But with knowledge you can dedicate a good entry for your trades to keep your risk as low as possible.
Determine important support and resistance levels and think about all situations what could happen and what will you do if you are going into the red or into the green? Which levels are the best entry and exit?
This all will help you to determine your riks/reward ratio.
What is the Risk/Reward Ratio?
Successful day traders are generally aware of both, the potential risk and potential reward before entering a trade.
The goal of a day trader is to place trades where the potential reward outweighs the potential risk.
These trades would be considered to have a good risk/reward ratio.
A risk/reward ratio is simply the amount of money you plan to risk, compared to the amount of money you believe you can gain.
For example, if you think a potential trade may result in either a $400 profit or $100 loss, the trade would have a risk/reward ratio of 1:4, making it a favorable setup. Contrarily, if you risk $100 to make $100, the trade has a risk/reward ratio of 1:1, giving you the same type of unfavorable odds that you can find in a casino.
Which ratio should you desire?
Like described above, finding trades with high risk/reward ratios (1:2 or higher), will help you maintain higher average profits and lower average losses, making your trading strategy more sustainable.
The common suggestion between traders is a distribution of minimum 1:2 ratio. In reality there are often even better ratios available, if you do your technical chart analysis.
But what should you do if you have to cut losses?
We have to place our stop loss right below our support or other important levels we determined before.
The purpose is to cut losses before they grow too large. Stopping out of a losing trade can be one of the hardest things for traders to do consistently. However, failing to take stops can result in margin calls, unnecessarily large losses, and ultimately account blowouts.
How big should I enter a position?
To lower your risk I recommend to think about your size to enter a position.
Overall you shouldn´t risk money you need, only deposit money in your broker you can afford.
Entering small can be the smartest way to safe your account.
I suggest that because of four reasons, the first reason is, you don´t risk to much of your funds and your stop loss should be tight anyway.
The second reason is, you can average down if the price is going in the other direction, but consider this option only if you are sure what you are doing.
The third reason is, you can buy the dips/pullbacks if the trend is strong and still heading in your desired direction.
In addition, the fourth reason is, your emotional control is stronger if the price movement is heading in the wrong direction.
That brings me to another topic.
Should you use leverage?
Yes I know, big leverage will give you big gains...but as a beginner you will not have the experience to know which trade has a very big potential or not.
Even experienced traders use only a small amount to enter a position and not the whole fund.
If you use leverage the losses can be much higher and the problem with that is, if you lose money, your leverage will also decrease significantly and the losses are harder to recover after each loss.
So the answer of the question, if you should use leverage:
For beginners we can easily answer: Take your hands of a big leverage!
You can so hardly blow up yourself with that tool, it is ridiculous. Your way back into the profit zone will probably take years.
But you have to save yourself and after a period of time, a period of taking profits and cutting losses you will gain knowledge until you feel much more comfortable on the market and you understand how trading really works, then you can consider to use leverage.
Conclusion:
As I said, I want to share only some big points about this topic, because I think many new investors don´t understand how important that topic is!
Safe yourself and have fun in trading and learning!
Sincerely,
TradeandGrow
Trade safe!
