Risk Management Techniques for Active Traders

• Losses may be minimized with proper risk management. Also, it may prevent dealers from having all their money disappear. When traders lose money, that’s the danger. Successful traders know that if they can control their risk exposure, they increase their profit chances.
• It’s a prerequisite for successful active trading, but one that’s not often given the attention it deserves. After all, without a solid plan to control losses, even a successful trader might see all of their hard-earned money disappear with only a few unlucky deals. How, therefore, may the most effective strategies for mitigating market dangers be developed?
• In this piece, we’ll look at several easy steps you can take to safeguard the gains you make in the trading market.
• CONCLUSIONS AND RECOMMENDATIONS
• Trading may be thrilling and potentially lucrative if you can maintain objectivity, do enough research, and control your emotions.
• However, even the most successful traders need to use risk management strategies to limit the extent of their losses.
• If you want to remain in the game, it’s wise to take a calculated and systematic approach to limit your losses through stop orders, profit-taking, and protective puts.

Planning Your Trades

• As the Chinese military commander Sun Tzu once famously observed, every fight is won before it is fought. This idiom emphasizes that fights are not what decide wars but rather strategy and preparation. Also, “Plan the deal and trade the plan” is a typical mantra among successful traders. Like in battle, good preparation is frequently the difference between victory and defeat.
• Be sure that your broker is suitable for regular trading before you start. Investors who make occasional trades may find brokers that better suit their needs. However, their commission rates are excessive, and they need more analytical tools for severe traders’ needs.
• A trader’s ability to anticipate potential outcomes is greatly enhanced by using stop-loss (S/L) and take-profit (T/P) levels. Successful traders can clearly articulate their maximum purchase and selling prices. Then they may compare the returns to the stock’s potential for reaching their targets. Finally, they make the deal if the after-tax profit is large enough.
• Conversely, failed traders sometimes initiate a transaction without determining if they will profit or lose on the trade. Instead, like gamblers on a hot (or cold) run, traders might let their emotions control their decisions amid a dramatic fortune swing. As a result, it’s common for investors to hang on after suffering a loss with the vain goal of recouping their losses and for traders to ride out a good run to maximize their profits.

Consider the One-Percent Rule

• Day traders often use the one-percent rule. However, a general rule of thumb is to never risk more than one percent of your trading account or money on any given deal. Keeping this in mind, if you have $10,000 in your trading account, you shouldn’t have more than a $100 stake in any asset.
• Those with trading accounts worth less than $100,000 often use this tactic, and some even use a spread of 2% if they can afford it. However, as account balances rise, many traders may choose a lesser proportion. That’s because the position grows in proportion to the amount of your account. The most straightforward approach to limit your losses is to keep the rule at 2%; over that, you risk losing a significant portion of your trading capital.

Setting Stop-Loss and Take-Profit Points

• The point at which a trader sells a stock at a loss is the “stop-loss point.” In the event of a deal not going as planned, this is a common occurrence. The goal of the points is to discourage an “it will come back” attitude and cap losses before they get out of hand. If a stock price drops below a critical support level, for instance, investors generally sell immediately.
• However, a take-profit point is a moment when a trader sells stock to realize a profit. When the costs limit the potential gains, this is the case. For example, suppose a stock has made a significant upward move and is getting close to a crucial resistance level. In that case, traders may want to get out before consolidation begins.

How to More Effectively Set Stop-Loss Points

• Although technical analysis is often used to determine when to implement stop-loss and take-profit levels, fundamental analysis may also play an essential part in this process. To illustrate, if a trader is holding stock in anticipation of results and excitement is building, the trader may decide to sell before the news reaches the market if expectations have been too high, regardless of whether or not the take-profit price has been reached.
• The most common method for determining these values is based on moving averages since they are simple to compute and commonly followed by traders. The averages of 5, 9, 20, 50, 100, and 200-day days are significant. The easiest way to determine whether a level will work as support or resistance for a stock price is to apply it to the chart of that stock.
• Stop-loss and take-profit targets may also be advantageously positioned along trend lines of support and resistance. You may make them by joining the points where volume was unusually high at the prior high or low. But, similar to moving averages, the key is locating the price levels at which the trend lines begin to get significant activity.
• These factors should be taken into account while deciding on the final values:
• Stop-loss orders are more likely to be executed due to meaningless price swings in volatile companies. Thus, it’s best to use a longer-term moving average when trading these stocks.
• To get the desired price ranges, the moving averages must be modified. Longer objectives, for instance, need more room for error. Therefore, more excellent moving averages are recommended.
• Stop losses shouldn’t be placed any closer than 1.5 times the current high-to-low range (volatility), or else they’ll be triggered for no obvious reason. If they are, the trader will have lost money for no apparent cause at all.
• Take market volatility into account when setting the stop loss. When there is no volatility in the stock price, stop-loss points may be moved closer together.
• When entering or exiting a trade in times of high volatility and uncertainty, focus on actual events that you know will have a significant impact, such as earnings reports.

Calculating Expected Return

• Estimating returns requires setting stop-loss and take-profit levels. This calculation’s significance must be emphasized since it compels merchants to carefully consider and defend their trading decisions. It also provides a systematic approach to evaluating potential transactions and picking the most lucrative ones.
• To do so, use this formula:
• Multiplying the likelihood of profit by the percentage profit that may be taken at any time yields the formula. + [(Loss Probability) x (Loss Stop-Limit Percentage)]
• This computation provides the active trader with a predicted return, which may be compared to other possibilities to choose which stocks to trade. For example, breakouts and breakdowns from previous support and resistance levels may be used to estimate the likelihood of a price increase or decrease, or an experienced trader can use their intuition.

Diversify and Hedge

• You should spread your investments across several markets to maximize your trading potential. Investing all you have in just one stock or asset is asking for trouble. Keep in mind the importance of spreading your money around by investing in different things and other places, not only companies or industries. This not only aids in risk mitigation but also provides you with new avenues for exploration.
• It’s possible that you’ll reach a moment in time when you realize that you need to find a happy medium. When the results are announced, think about buying some shares. It’s possible to hedge your bets by adopting the opposing position using options. You may remove the hedge when trade activity slows down.

Downside Put Options

• If you can trade options, you may protect yourself against a bad deal by purchasing a downside put option, often known as a protective put. You have the right, but not the responsibility, to sell the underlying stock at the option’s strike price on or before the option’s expiration date if you purchase a put option. Therefore, if you now possess $100 worth of XYZ stock and pay $1.00 for the 6-month $80 put option premium, you will be effectively shut out of the market at a price below $79 ($80 strike less $1 premium paid).

The Bottom Line

Before making a transaction, investors should clearly know when they want to enter and when they want to get out. If stop losses are used properly, a trader may reduce the frequency with which a trade is closed prematurely and, in turn, the amount of money lost. In conclusion, plan your strategy ahead so you can be sure of your victory.