Risk management can be about complex formulas and rules, but it can also just be a matter of common sense. While various techniques and measures can reduce risk in both discretionary and algorithmic trading, many successful traders have relied on common-sense principles for years. Here are some of these valuable principles listed for you.
1. Limit Your Risk: Never put too much of your total capital into a single trade. The amount at risk should allow you to comfortably weather multiple consecutive losses. It’s advisable not to ever risk more than 5% of your invested capital on any single trade.
2. Define Exit Clearly: Always establish clear exit conditions in advance for every trade, even if you can’t predict the exact loss in advance. Having predefined exit criteria helps you make rational decisions under pressure.
3. Beware of Size: Be cautious when profits or losses become disproportionately large relative to your initial investment. In such cases, consider reducing your position size to manage risk effectively.
4. Exit Promptly: As soon as you realise a trade is going against you, exit it swiftly. Don’t try to salvage a losing trade; experienced traders often believe that the smart move is to cut losses early.
5. Prioritise Liquidation: When scaling back your positions, start by liquidating your worst-performing positions first. Strong trades demonstrate their viability, while weaker ones signal their inadequacy.
6. Consistency is Key: Stick to your chosen trading philosophy. If you’re a trend follower, keep losses small and let profitable trades run their course. Consistency is essential for successful trading.
7. Match Your Risk Profile: Ensure that your trading strategy aligns with your risk tolerance. Don’t engage in a strategy that involves uncomfortably high risks; choose a profile that suits your comfort level.
8. Plan for the Unexpected: Always prepare for contingencies. Trading rarely goes exactly as planned, and you should be ready for infrequent but critical events, such as sudden price shocks. Being adequately capitalised is crucial for handling such situations effectively.
By following these rules you can help yourself manage risk in a more effective way without the need for a complicated formula.