Risks are what is holding many traders back when it comes to investing money. Fear of losing stops you from making any progress and, eventually, makes you go back to the known safety of your usual way of earning money.
That’s where the risk management strategies appear. Their point is pretty simple - to minimise the risks and allow enough freedom to use different trading strategies. Risk management helps you lose less and even cover your unsuccessful deals fully.
Many traders think that setting their Stop Loss and Take Profit levels are everything they need for their money management - however, there are many different points you need to cover if you want to make your money management strategy really advanced. Let’s review the main ones:
Add money to the winning positions
As obvious as this advice might sound, sometimes it’s easy to miss, especially if you hope that price will reverse soon. After all, people rarely want to buy at a high price just to get it to fall unexpectedly. And yet, it’s still wiser to make sure that your money goes into the deals that are guaranteed to bring you moderate profit rather than those that only have a chance of giving you a high reward.
Beware of earning reports
Holding your position open through earning reports or some major economic news can create a dangerous situation where the volatility can ruin your overall successful trading streak. Make sure to check the economic calendar in advance and set some reminders not to miss the important dates. Better be safe than sorry!
Calculate your risks in advance
For that, you should differentiate between active and passive risks.
The active risk ratio (alpha) measures an asset’s performance against a benchmark in time. The passive risk ratio (beta) measures an asset’s volatility against a benchmark in time.
Here’s how you can calculate them:
Alpha (α) = Rp – [Rf + ß(Rm – Rf)]
Beta (ß) = Covariance (Re, Rm) / Variance (Rm)
Rp: Return % of the portfolio – the return % of the portfolio in the chosen period
Rm: Return of the market – the return % of the benchmark in the chosen period
Rf: Return of the risk-free trade – the return % of a minimal-risk investment
Re: Return of the equity – the return % of the stock in the chosen period
A starting indicator for the alpha rate is zero. If you get a positive result, the return percentage will be higher than the benchmark. A negative alpha rate indicates a lower return. A higher beta rate indicates higher returns and higher risks, whereas a lower beta indicates lower returns and lower risks accordingly.
Diversify your portfolio
It’s crucial that you include different assets and trading instruments in your portfolio, depending on your current goals and possibilities. However, keep in mind that you should monitor every asset you invest in closely, so pick as many as you can follow without really dispersing your attention.
Set price targets
Knowing when to close your position is just as important as entering the market at the right time. Determining the desired price level to set your Stop Loss and Take Profit more mindfully is considered one of the main risk management strategies. To set it correctly, traders prefer using the following indicators:
Support and Resistance
Average True Range
Trading always involves a certain degree of risk. Still, with the correct risk management strategies, you can make sure that your losses are brought to the minimum and get your lost money back with new covering positions.
Here’s an additional checklist of the rules for your risk management - take it with you, it’s dangerous to go alone!