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While many traders focus on how to make a profit in trading, it is equally important to know how to protect your trading capital from losses. This is called risk and money management or money management.
In this article, we will discover why it is important to introduce risk management rules in trading, as well as the best tips to protect your capital when trading.
Why is risk management in trading important?
Risk management is important because trading is an activity that always involves a certain degree of risk. It is therefore essential to have rules introduced that allow you to better protect your capital in order to continue trading.
Indeed, financial markets are unpredictable. Without effective risk management, traders can suffer significant losses that can quickly deplete their trading capital.
Risk management allows traders to determine the level of risk they are willing to accept and make informed decisions based on their risk profile. Additionally, having risk management rules to follow helps limit the influence of emotions on your trading and maintain a more disciplined and rational approach to trading.
What are the most used risk management tools?
Among the most used risk management tools are the following:
the calculation of the size of the trading positions, which must depend on your risk tolerance, your trading capital as well as the leverage effect used or the characteristics specific to the traded market,
implementation of stop-loss stock market orders to limit your losses per position,
determination of a maximum loss per day or per week,
the use of portfolio diversification to spread risk between different asset classes, currencies or geographies
managing emotions to avoid making irrational emotional decisions
the hedging that limits potential losses by reducing the impact of unexpected market movements.
Some rules for risk management
Before you start trading, determine what type of trader you are to determine your trading profile and level of risk tolerance. This will help you decide which risk management rules to put in place and follow based on your profile.
However, there are a few risk management rules that can apply regardless of your trading style and strategy, as they are considered by many to be “one size fits all”.
For example, it is never recommended to trade without a protective exchange order to limit losses, especially if you have adopted a short-term trading strategy. These orders are called stop-losses.
There is also an order to close a winning position automatically as soon as it reaches a certain price level. This is a take-profit order.
You can use several methods to set your stop-loss and take-profit depending on your risk appetite. You can use support and resistance levels or a risk/reward ratio (2:1 or even 3:1 minimum) for example.
In general, a new trader should never trade more than 1 or 2% of his total capital on the same position. It is also advisable to never invest more than 30% of your total trading capital.
Finally, it must be emphasized that you should never trade with money you are not ready to lose, because there is a real risk of loss in trading. Also, you should never borrow money to shop.
Whatever risk management rules you put in place should be part of your trading plan. It’s also good to keep a trading journal to help you make sure you’re following your rules. risk management.
By taking notes on every trade you make, you can more easily assess the results of your trading decisions and analyze why a trade was profitable or not. This makes it easier for you to identify trends and repeating patterns in your trading. It is then easier to determine the necessary adjustments to your strategy.