The business of Risk Management is an essential lesson to learn when trading. Regardless of your skill level, you will need to find what works for you as an individual. In order to define what strategy you should use, it’s important to know how to classify risk and reward. This will help you make the correct choices for your individual trade plan.
Risk can be classified in many ways when trading. As we see it, risk is the amount of money you’re willing to lose in a trade. Know how much you are willing and able to lose in a day and make this a part of your trade plan. You should know this amount before you enter into any live trades. Then, set the distance between your entry point and your stop loss to match this amount.
Risk can be caused by any number of factors, some more controllable than others. Some risk scenarios under your control are your style of trading, having a trade plan, and setting a stop loss. Uncontrollable conditions such as volatile market conditions or news announcements must be handled differently. We suggest not trading into news and avoiding trades that don’t fall into your trade plan. Some days you may not find a setup that fits into your trade plan and that is ok. Avoid trading emotionally or “chasing” a trade once it has begun. If your trade starts to go wrong, stick with your rules and your stop loss once a trade is in motion. Changing these details after a trade has begun will usually do more harm than good.
While looking at risk is important, it is also good to weigh this risk against any potential gains. Reward is quantified as the profit potential on each trade. Select an appropriate entry for your trade setup and the appropriate targets based on what the market allows. The distance between your entry and target will be the basis for your potential profit.
Here are 5 things you can do right now to maximize reward and minimize risk:
- Look for clean trade setups based on your rules. If it seems too complicated for your current level, it is best to err on the side of caution and wait out a better option.
- Keep an eye on the trade environment. Be aware of news announcements and avoid trading into them. News announcements often cause unpredictable volatility in the market.
- Trading with half-size orders is another way to reduce risk while still maintaining reward potential. Don’t be worried about “not trading big enough” if your account does not allow it.
- Learn to be good at what to do. Keep a cool head and follow your rules for trading. There is no such thing as a risk-free trade.
- Keep a journal so you can measure your consistency with different trades that you take. Review & refine your trade plan with this knowledge as you gain experience trading.
