A novice trader who imagines trading as a lottery is deeply mistaken. Risk management in trading is a necessity at all times, especially when someone is day trading with $1000 and has no financial cushion to save them from going bankrupt.
Below are several essential risk management principles from FX2 Funding, a proprietary trading platform. You can freely adopt these principles to your needs to successfully evade risks and make good money on the stock exchange.
Use Multiple Instruments
Committing all capital to a single stock (or any other security) is too risky. For that reason, traders are recommended to use at least 3 to 4 exchange instruments. In this way, they will always have plenty of time to study all the strengths and weaknesses of each one of them. Dividing money by instruments, which is called differentiation, is a good preventive measure from losing deposits at the initial stage of trading.
Never Invest More Than Half of Your Capital
Unlike the previous one, this principle applies to both beginners and more confident traders. To help you better understand it, consider these situations:
- Suppose you have a very attractive, promising project in front of you. You are one hundred percent confident in the deal. However, investing all or nearly all of your funds would be as risky as putting all your eggs in one basket.
- Imagine you spend all your time working at one job. If you lose this job, you are at a high and imminent risk of losing your income completely.
To mitigate the above-mentioned risks, you can diversify your investments, or organize several sources of income (jobs) to minimize the likelihood of disaster from losing one job.
Always Evaluate the Risks
At first glance, it may seem like a difficult task, but if you at least keep statistics on all of your transactions, that would massively aid your risk management efforts. Keeping statistics helps a trader not only analytically, but also emotionally. To make as few mistakes as possible in assessing risks, we also advise you not to rely on leverage and to always calculate the approximate drawdown per transaction.
Do Not Risk More Than 5% of Your Capital in One Position
There is a dependency between the percentage of the amount at risk and the size of potential losses in that amount. In everyday life, this can be compared to the inflation rate. Five percent can be exchanged for any other percentage that is comfortable for you. The key is not to forget about the interdependence between the risk share of one transaction and the total loss.
The Main Takeaway
Just accept that you will lose some money in trading, as this is an inevitable part of earning from stock and currency exchanges. Your task here is to monitor the market as calmly as possible, evaluate risks, and be vigilant. Everything will definitely work out with experience if you don’t give up and prove to be prudent enough in assessing and evading risks.
