Risk Management Techniques for Active Traders

Before becoming an active trader it's best to tread cautiously; for starters make sure you have a risk management plan. Risk management is very important to traders who are actively involved in the markets. Your livelihood is at stake, that's why the rules you set are an important first step. It is a proven fact that most amateur traders lose money starting out. Yet surprisingly, it is also a fact that professional traders lose money on most of their trades. That's why risk management is so important. It's important to approach the markets from a standpoint of managing risk as opposed to maximizing returns when first starting out. 

Planning the trade

You always want to plan the trade. Whether it be a rule of thumb, or going off of a stock tip. When going forward with a stock tip or a hot lead, make sure you understand the rules of trading from a standpoint of a risk manager. Some techniques include the following:

  • Make sure you have cash
  • Don't have more positions than you can handle
  • Diversify effectively
  • Allocate effectively

Diversifying effectively means you must have fundamental diversification in their trading approach. Diversification is about spreading the risk so that it is not concentrated in just a few positions. Allocating effectively means not having more capital devoted to the trade than a proportionate fraction of all the planned trades. For example, if you want five total trades, not more than one fifth should be devoted to a single trade.

Closing the position

Knowing when to close the position is key. As mentioned before you would want to focus on managing the overall risk However, learning to close the position is also important. When you plan the trade properly you will find that certain trades may not have a good chance  of winning. It is best to close the position sooner rather than later.

Stop loss

A stop loss is a market order type that designates when to sell at the outset of opening the position. There can be any stop loss threshold amount that you're comfortable with. Knowing when to sell is key and a stop loss is an automatic way to cancel the trade, albeit at a loss. Remember that a small loss is better than a big loss.

Profit taking

Taking profits should become easy as time goes by. However, if you plan on trading in the very near term, always remember that a profit should not be taken for granted. A general rule of thumb would be to make sure profits are at least twice the loss allowed for the stop loss.     

For example, let's say stocks are mostly up, but there are major signs of weakness in the market. This would be a good time to diversify effectively and trim any profits from the positions that are doing well even if they have not met your goal in the profit zone. When the stocks are mostly down, your risk management plan is put to the test.

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