Risk Management in Trading: Why is it Important
When it comes to active trading, the knowledge of risk management techniques are perhaps as important as profit making ones. However, due to greed, impatience or mere inexperience, this also happens to be one of the most widely ignored prerequisite with most active traders. Generating profits comes to nothing if you do not have the ability to control your losses. In fact, all the profits made over several trades can be lost over a single bad decision. This is why risk management in trading is an absolute must.
Make sure you plan your trades
Getting into trading without a definite plan is like walking into a frozen river with no life raft. In fact, planning your trades well is one of the best ways to control and even reduce the chances of loss. It is therefore important to plan your trades well and more importantly, stick to these plans when you are trading actively. While a lot of us may formulate plans, we often lose our way due to unexpected movements.
If you are looking to play your trades, take-profit (T/p) and stop-loss (S/L) are two terms you must be closely familiar with. Any successful trader is equipped with the knowledge of buying, selling and holding prices. In this light, a successful trader measures the probability of stocks hitting required targets to make substantial returns. If this probability is high, he/she goes ahead with the trade. On the other hand, an inexperienced/unsuccessful trader gets into trades without any real understanding or expectations of these movements depending solely on luck. This gambler-like approach may succeed rarely but it lands traders with losses more often than not. Another tell-tale sign of an inexperienced trader is trading by emotion and not by reason. In this situation, losses induce panic and profits push these traders towards holding positions in the lookout for further profits.
Take-profits and stop-loss
The first thing to do for any trader is to steer clear of these common mistakes. Instead, the first thing to do is select a stop-loss point for trading. This point refers to a price at which a trader will sell a stock and sustain the minimum amount of loss instead of holding one’s position and letting things get worse. This approach is helpful to prevent a trader from experience of false hopes that it will all come back though he/she is experiencing building losses on a single trade.
Another great risk management technique is based on setting a take-profit point. This point lies on the other side of the table in contrast to stop-losses. Assuming that a trader is experiencing building profits on a single trade, he/she must set a point to sell off the stock and collect the corresponding profits. As trades reap profits, it is natural for an individual to get a bit greedier and want to hold on to the stock for a bit longer. However, this approach may turn turtle if the stock value drops and doesn’t recover. In other words, stop-losses and take-profits are ways to set lower and upper limits to trades so there is more consistency in trading.