When you engage in online trading, it’s essential to have a strategy. A signal for entry a key component but even more critical is your risk management. Risk is the amount of money you are prepared to lose when you place a trade. Before you enter any transaction, you should have a clear idea of the risk you are willing to take. Your risk will also change as the market moves, which means that you need to have a risk management plan in place as part of your trading strategy before you begin to trade.
What is Risk Management
Trading the capital markets requires a strategy that incorporates a reason to enter a trade and several rules that will provide you with information about when to exit a trade. Before entering a transaction, you should determine where you will enter a trade and exit a trade. Your exit criteria have multiple variables. The first variable is your risk. How much are you willing to lose to enter a trade. The amount of risk you are ready to assume should help you determine your profit potential. A prudent measure of profit is a multiple of your risk. Once you have your exit criteria in place, you can set a stop loss level and a take-profit level.
A stop-loss order is a market over that you provide to your broker, which will execute if the price or exchange rate reaches a specific level. You can either execute this order yourself or place it with your broker. The stop-loss order will execute a trade at a price once your stop-loss trigger level is hit. If you think many people will be performing stop-loss orders at a specific level, you might consider placing a stop loss limit order. For example, if the low of 10-days is 1.1850 on the EUR/USD and you place a stop loss level at 1.1845, your execution price might be 1.1835 if there is a lot of volume trading after 1.1850 is breached. To make sure that you don’t lose an additional 15-pips, you can place a stop-loss limit order where your stop-loss is 1.1850, but your limit price is 1.1845. This order means that you don’t want execution at a level less than 1.1845.
Another type of risk management occurs when you are trying to trade a trend. To avoid taking profits too early, you can use a trailing stop-loss order. A trailing stop-loss follows the markets higher or lower. For example, you might enter a long EUR/USD trade at 1.20 with a stop loss at 1.19. If the exchange rate increases to 1.21, you might increase your trailing stop loss up to 1.21. As the market rises, you increase your stop loss level to catch the trend. When the market eventually turns, you will be stopped out, which equals your stop loss level.
The Bottom Line
There are several techniques that you should consider using to envoke a risk management plan. Before you enter a trade, you should have a clear idea of where you plan to take profits and where you plan to take your loss. Remember, the risk is how much money you might lose on a trade, not the actual loss. You can use stop loss and take profit orders to help you with your risk management. You can also consider using a trailing stop-loss order if you plan to follow a trend.