New traders quickly learn that risk management is one of the most fundamental aspects of trading. It’s so fundamental, in fact, that it has spawned a whole literature on how to optimize investment decisions.
Risk management can be complicated or it can be easy. When you find the right place to use risk management it can be very simple. Your best bet is by using a trading platform which gives you access to all the tools you need, to manage risk in one place.
Risk Management: A Definition
In plain English, risk management is the process of identifying, analyzing and accepting the role of uncertainty in investment decisions. When it comes to financial instruments, risk management occurs when a trader analyzes potential risks and takes proactive steps to lessen them.
It’s easy to think of risk management as the tools you need to do your best to prevent unforeseen loss in the financial markets, or more realistically, limit that loss.
How to Approach Risk Management
You can go about your risk management plan by considering following:
- Negative balance protection
Risk Management Through Diversification
Diversification is critical to risk management because it tells us never to put all our eggs in one basket. From a financial perspective, this means building a portfolio around various asset classes instead of relying on just one. Finding a broker which offers access to 300 or more markets in a variety of products such as forex, commodities, indices and CFD markets, can help you build a well-diversified portfolio. In some cases you can even find more products such as vanilla options and forex forwards.
Risk Management Through Guaranteed Stop-Loss
A stop loss order, or simply stop loss is an essential function for successful traders because it minimizes downside risk in the event a trade goes against you. By placing a stop loss, you are essentially telling your broker to sell an asset when its price reaches a certain level. Even if you are not monitoring your account at the time, once a stop loss is placed it will work automatically. What you need to look for is a ‘guaranteed’ stop loss, as not all platforms allow you to exit a trade at the exact price you specified due to many reasons including slippage.
Risk Management Through Take-Profit
A take-profit order is the opposite of a stop loss. It tells your broker to sell an asset after it has already booked a profit. That way you can “lock in” profits when they occur. Although a take-profit order might limit how much money you make on a trade, it can also keep you disciplined, and hold you back from losing the profits you’ve made, if the market moves against you at a later point.
Risk Management Through Negative Balance Protection
With some brokers, if you go to bed with a losing position you might wake up not only with a loss but also owing money. In this day and age you shouldn’t settle for a broker that does not offer negative balance protection. With negative balance protection, once you lose your invested capital your positions are closed, and it does not go into negative territory. This means you never lose more money than you deposit into your account.
Even though this is one of the strongest risk management tools, especially for a beginner, it is also a unique tool which you can only find at easyMarkets. With dealCancellation traders can undo a losing trade within 60 minutes of placing it. If you’re worried about trading a volatile news release, rest assured your balance is safe if you trigger the dealCancellation on your trading account. For a small fee, you can undo any loss you incur over the next hour, letting you focus on making trades instead of worrying about potential losses.
Is Risk Management the Answer to Successful Trading?
The short answer is no! But risk management is an essential part of trading, and by limiting your risk, you have a better chance at limiting your losses and hence increasing your profits. Taking your time to understand risk management tools and using them is an investment in itself.
*Terms and Conditions Apply