Some trading experts may suggest that choosing a suitable risk management approach might determine the outcome of a trading session. In fact, by applying the appropriate money management techniques and tools, traders may achieve several key targets. These include understanding market dynamics, evaluating risks and adjusting trading methods according to changing market conditions.
So what exact steps might traders take to develop a suitable risk-management approach? Here are 7 money management techniques that might help improve your trading method and manage risks efficiently.
1. Choosing the capital management approach
There are two main ways of handling one’s capital: the conservative approach for cautious traders and the slightly more aggressive approach for those with experience. No matter which method you may pick, the most important part is to stick to it as much as possible.
The conservative method implies an investment of not more than 1% of the trader’s balance in one deal. It also suggests using no more than 3% of the whole balance at any given time. For example, if the total balance of a trader is $100, they can only trade with 3% of it at once — an amount of $3. They may open 3 deals of $1 investment each. This method may be more convenient for novice traders as it requires fewer funds for trading.
A more aggressive method suggests investing up to 5% in a deal and utilizing not more than 15% of the balance at once. This may allow a trader to open 3 deals, for example, with a 5% investment at a time. This method may be used by more experienced traders with a more in-depth understanding of their trading methods and assets. With that said, traders might also consider diversifying their risks so that their potential losses wouldn’t exceed 5%.
2. Diversifying your portfolio
Choosing just one or two assets and only trading on those can be quite risky. The market can be unpredictable, and opening multiple deals on the same asset may cause unnecessary losses. Experienced traders might choose at least 4–5 assets. They may focus on different instruments, such as CFDs on Stocks and Forex, Crypto and ETFs that are available at different times. This way, the trading conditions for these assets would differ slightly. Adding diversification to a trader’s portfolio as one of the money management techniques may help manage potential losses and risks that may occur.
If you would like to learn more about portfolio diversification methods to manage risks in trading, have a look at this video for a deep dive into this topic.
3. Finding the right entry points
There is no way to be 100% sure about the most suitable moment to enter a deal. However, there are some ways to identify trading opportunities and evaluate their potential. They include utilizing technical and fundamental analysis, following the news and analysing the market to gather as much information as possible. Traders may want to plan their actions in advance to avoid spontaneous decisions and common trading mistakes.
4. Trading longer timeframes
Trading indicators may be a helpful part of a risk management approach. However, traders should not make decisions based only on their indications. These can be misleading, especially on very short timeframes (unless specifically designed for short-term trading).
That is why some novice traders may sometimes choose longer timeframes. Short-term trading may involve more risk, as traders might need to act fast without thorough analysis. Aiming for a longer period might allow traders to gather the necessary information and make informed decisions. Nevertheless, the trading periods used are always depending on a trader’s preference.
5. Hedging
Hedging is one of the most popular money management techniques to manage risks in trading. This involves opening a reverse position on the same asset to protect the capital in case the asset price goes in the wrong direction. For example, a trader may open “Buy” and “Sell” positions on the same CFD asset to cover for a possible wrong prediction.
While hedging may be useful for managing risks, it may also work against the trader by cutting their potential positive outcome. This method might be more suitable for experienced traders, as it requires some practice. In any case, it is always up to the trader to pick their approaches according to their goals and preferences.
6. Setting a trading limit
Experienced traders may often follow some rules when it comes to daily trading. One of the most important ones is setting the limit for the number of deals in a day to manage risks in trading. Alternatively, they might limit the number of unsuccessful deals in a row. This limit can be a lifesaver when a trader is exhausted and starts giving into emotions. Taking a pause between trading sessions may help cope with some psychological factors, let go of the tension and mentally prepare for trading again later.
7. Analysing your performance
Many traders do not analyse their performance and don’t keep track of their deals. This means that they do not recognize their mistakes and, therefore, cannot fix them. Keeping track of all the investments, their results and the outcome is essential to achieve positive results. Otherwise, traders might repeat the same faulty pattern again and again. This is where a trading journal might come in useful. Have a look at this material to learn more about this tool: Why Keep a Trading Journal?
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