7 risk management rules that must be respected when trading – 15/04/2024 at 12:30 p.m.

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The key to success in trading lies largely in good risk management, that is, following a set of rules based on your risk appetite and trading style. In this article, we will look at the 7 most popular risk management rules that will help you minimize potential losses, better protect your capital, maintain discipline in your approach to trading, avoid impulsive trading decisions and ultimately improve your prospects for long-term success.

1) Only invest money you don’t need in the short term

Losses are inevitable in trading. If you risk more capital than you can afford to lose, the probability of losing everything increases, and with it your financial stability and future security (especially if the funds are essential to your daily life). Fear of significant losses can also cloud your judgment and lead to costly emotional trading decisions that deviate from your trading strategy, further amplifying the risk of loss.

2) Never borrow to invest

Loans to invest also amplify potential losses. So even a minor market decline can lead to a snowball effect that ends up in greater debt, turning a small trade setback into potential financial ruin. In addition, loan repayments add fixed costs to potential losses, creating greater financial pressure. Margin trading further compounds this pressure, requiring additional funds to be deposited or potentially closing positions at a loss. The pressure of repaying borrowed funds can also affect your analysis of the markets and lead to impulsive trading decisions.

3) Diversify your investments

Rather than relying solely on the performance of one asset class, such as stocks, spreading your investments across different asset classes, such as bonds, commodities, cryptocurrencies and indices, for example, can mitigate the impact of market fluctuations. When one asset class experiences a downturn, others can perform well, helping to offset losses and stabilize your portfolio. In addition, a diversified portfolio generally exhibits lower volatility compared to a concentrated portfolio. Diversification also allows you to adapt more effectively to changing economic and market conditions while taking advantage of more trading opportunities as you target different markets.

4) Invest a maximum of 2% of your capital per trade

The 2% rule supports the idea that only a small portion of your capital is at stake via each trade position taken. You thereby create a buffer that protects you against significant losses, and you spread your capital over several positions. Additionally, by reducing the fear of large losses, you can approach trading with a clearer and more disciplined mindset. Thus, the 2% rule promotes a more sustainable approach to trading, ensuring that even in the event of small consecutive losses, you retain sufficient capital to continue trading, learn from your mistakes and refine your strategy over time.

5) Always use stop-loss and take-profit orders

A stop-loss order serves to limit potential losses by triggering an automatic exit from a losing position when the price reaches a predetermined level, while a take-profit order helps to secure profits by automatically closing a winning position, when the course reaches a certain target level. Stop-loss and take-profit orders act as automated risk management tools that protect traders from unexpected market fluctuations. Additionally, they also eliminate emotional decision making from the trading process and promote a disciplined and objective approach to trading which can improve overall performance.

6) Learn to control your emotions

Market fluctuations are inevitable and the dynamic trading environment often gives rise to intense emotional reactions such as fear, greed or overconfidence, which can lead to impulsive decisions that deviate from your trading strategy and can cause significant losses. However, it is important to base your trading decisions on an in-depth analysis of market trends, on technical indicators and/or on fundamentals depending on your strategy.

7) Include these various rules in a trading plan and always follow it

A clearly defined trading plan that incorporates these fundamentals will serve as your guide, help you reduce risk and preserve capital, demonstrate discipline and objectivity in your trading, and potentially improve your long-term success. By providing a structure with precise guidelines for entering and exiting your positions, as well as risk controls, it allows you to mitigate impulsive decision-making arising from emotions or transient market changes, while still promoting accountability for your actions in trading.

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