Risk management in trading: calculation rules, how to

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

The topic of trading is relevant for all readers who are interested in the stock market. Specialists are well aware of the need for professional risk management when making any financial transactions. However, not all beginners are aware of this. If you do not follow the rules of risk management in trading, you will lose your trading account or some part of it for a short time. Let's try to do without highly specialized terms that are simply unfamiliar to many, making up a definition.

What is this?

Risk management in trading is somewhat like an airbag in a car. The only difference is that it is intended to save capital, not life.

That is why it is so important to know the rules of risk management in trading and be able to apply them in practice. This is especially true for beginners who have not yet comprehended all the features of the functioning of the stock market.

Swhere to start?

The first thing a future professional trader should learn is to trade at zero. Simply put, he should at least not lose money when making transactions. Only after that is it worth learning to earn. Almost no one manages to bypass this stage. Some traders already in the first months of their activity begin to receive income. However, in doing so, they skip the stage at which comes the realization that they have to work in an aggressive environment.

There is a risk of quickly becoming an expert. However, no one is immune from sudden and painful drops in the stock market. For the same reason, do not despair, not receiving income immediately. If you believe the statistics, then almost half of the transactions carried out can bring a negative result. That is why it is so important to apply risk management in trading.

Basic rules

Let's list them briefly and then discuss them in more detail:

• Don't invest more than half of your capital.
• Keep your risk tolerance.
• Keep a balance between diversification and concentration.
• Set stop orders.
• Determine the rate of return.
• Open multiple positions.

Don't invest more than half of your capital

If you want to be successful in the financial market, try not to invest all your funds exclusively in one project. Try to leave most of the capital for other transactions.

Moreover, someexperts in the stock market recommend using no more than thirty percent of the capital to participate in the transaction. The lower the number, the better.

Try to distribute capital among several projects, thus insuring yourself against the potential risk of ruin.

Stay risky

According to experts, this figure should be no more than five percent of your capital. By following this principle, you will ensure that the loss ratio will be no more than 5 percent of the capital. This figure does not even exceed the inflation rate. Depending on the area of investment, the level of risk can be reduced to one and a half percent. This is one of the basic rules of risk management in trading, which allows you to prevent the possible loss of capital.

Keep a balance between diversification and concentration

The ability to distribute funds between several projects is called diversification. Using this risk management strategy in trading, the calculation is made to reduce probable losses. Concentration is the concentration of an impressive part of the capital in one market or in one project. That is why it is important to strike a balance between diversification and concentration. Experts recommend using an average of no more than ten investment instruments. This allows you to distribute funds in such a way that if one group falls, the losses are compensated by the growth of the others.

Set stop orders

To avoid huge losses whenprice changes, set the so-called stop loss in advance. This will lock in the price, thus allowing the trader to close the position. However, before using a stop order, it is advisable to perform market analysis. However, the willingness of the trader to take a certain risk is equally important.

Determine the rate of return

For any, even potential, transaction on the stock market, experts recommend determining the ratio of profit and loss. This forecast allows you to balance the risks. If the desired ratio cannot be achieved, it is recommended to completely abandon the use of this investment method.

This is an important risk management tool in trading. How to make the rate of return, each participant in the stock market decides independently. It depends not only on the characteristics of the activity, but also on the nature of the participant himself. Some are more willing to take risks and are not afraid to make trades they are not sure about.

Open multiple positions

If several positions are available on the stock market, provided that an identical instrument is used in each of them, the trader must pre-select trading and trend positions. The first are intended for short-term trading. The second are designed for a long period.

How to protect capital?

When making transactions in the stock market, a trader should pay special attention to protection from participation in transactions that do not generate income. To this end, even professional players are trained in money management.

The main rule is not to risk impressive sums. In each transaction, you should try to use the minimum part of your capital. The smaller the amount of the transaction, the lower the risk.

How to create your own strategy?

People who have been developing in the stock market for a long time know that there are no universal solutions. Each player independently builds his own strategy, guided by the acquired knowledge and practical skills.

Beginners tend to try to get as much information as possible from available sources. They read news and professional articles, visit forums and ask questions of experts. Based on the information received, they make their own conclusion regarding the advisability of buying or selling.

This method really allows you to collect a lot of information, but due to lack of practical experience, it can lead to unsuccessful actions.

In addition to theoretical knowledge, you need to have real strategies. In practice, traders rarely wait longer than a month to see what happens. Money must constantly rotate and make a profit. The strategy called "buy and hold" is relevant only in very profitable markets. However, you need to be able to accurately determine the moment for the most profitable sale of securities.

Basic Strategies

Investors know some of the most popular ways to conduct transactions:

• Scalping. It involves making a large number of small transactions that bring the trader a low, but almost guaranteed profit. The main disadvantage is that untimely interruption of transactions reduces the profit of the investor. Another disadvantage is that a massive negative trade can nullify the positive effects of everyone else.
• Intraday trading. The transaction in this case is completed within one day. The main disadvantage is that you need to make positive trades daily. This creates psychological pressure that results in poor decision making.
• Positional trading is considered one of the most popular. This option is chosen by a significant number of players.

As you understand, it is especially important to follow the rules of risk management in trading for beginners. This is due to the fact that it is beginners who are prone to commit the greatest number of mistakes. That is why, at the beginning of their professional career, they should bet not on making a profit, but on the ability to preserve capital and avoid losses. To this end, one should study books on risk management in trading and other available sources.