By now, you would have understood the psychological consequences of risking. Now we will see how to reduce risk while making bigger profits.
Minimizing risk using Money Management
The most common way of money management is by the setting of stop losses. A stop loss is an order that is set by a trader that gets triggered when the market reaches that price. It is used to control risk. Traders set stop losses based on a number of parameters such as trend lines, range borders, highs, and lows in the market. They are usually determined during the planning stage of a trade. But not many know the psychological ways to set up a stop loss. Here we will look at each way.
- The first method is by putting a stop loss before entering a trade. It eliminates emotions and nervousness. Mechanically, it is the fastest and safest way of executing an order. There is also a disadvantage of keeping such an order. Since the market knows where all the stop losses might be, it can create spikes and stop you out from the trade.
- The second way is to enter your stop-loss order with your broker only. This way, the market will not be able to find out where most of the stop losses are. You will not be a victim of spikes. But you need to trade with a broker who is trustworthy and reliable. Nowadays, most of the brokers are providing this facility. So when you put a stop loss, it stays with the broker until it is triggered by the market.
- The third and best way is by having a mental stop. It has the biggest advantage of letting the market tell you where it wants to go. This is true for experienced traders. If you have time to watch the market until you close the trade, then this might be a suitable method for you.
Along with money management, there are other methods which are equally important to reduce risk. You should use these methods collectively to get the maximum gains.
Diversification of portfolio
If you select stocks that are independent of each other, in movement, then three different positions are sufficient to diversify your portfolio. If one stock goes down, you will not be in huge loss as other stock will go up. Selecting one stock from the metal sector and one from the real estate sector, for example, is an independent stock selection. Another form of diversification may include stocks, commodities, and forex since all these are relatively independent. People make the mistake of investing in correlated stocks. If the stocks go down, then your entire portfolio goes down.
If you are trading multiple markets at once, you need to be able to handle all of them together. Traders who trade in one specific market are mostly expert in that sector as they understand it’s working. Traders who trade in multiple markets have the advantage of diversification and increased opportunities.
Most traders make the mistake of using high leverages to make big profits. By doing this, you are risking more than 1% of your account and increase your risk exponentially. If you still wish to trade the futures market, you could do it by reducing the leverage. Or when your account size is big enough to handle such a loss. The goal is to reduce the risk factor as much as possible. You can make use of another market segment known as options where you need to spend only on the premium. There are also many strategies that you can use effectively.
Take only low-risk trades
Take only those trades that you feel have the highest probability of success. Your goal is to minimize risk in every possible manner. It is totally okay if you miss a trading opportunity. There is always another opportunity that the market will present to you.
Making the best risk to rewards
There is the type of traders who do not make large profits consistently. But they can make reasonable profits with consistency. Making profits consistently also means they are consistently right in their direction of the market. This partly comes from expertise. They have the skill to take profit from the trade before it turns into a loss. By doing this, you can also reduce risk consistently.
The next important characteristic of risk to reward is the size of your profits to the size of your losses. If your winning rate is less, then you should let your profits run. Because only if you make big profits, you can outweigh your losses. This is the only way of having consistent high returns with low risk.
You might have an excellent plan for your trade. It can give you profit only if you are able to follow it without hesitation. And following the plan is the easiest of all. This also requires self-control. Therefore we can say that:
” It is you who determines your trading success.”
The tasks involved to control yourself include self-analysis and taking good care of yourself when you are out of the market. You must do these tasks routinely. There are also other issues that you face when you are trying to control yourself. For example, it can lead to stress, and stress is not good for trading and your overall performance. It also takes away the effort put to reduce risk.
Other issues include conflict and beliefs in your mind that make minimizing risk even more difficult. You might have a fear of taking a trade. As such, you may lose a low-risk trade. On the other hand, if you are overconfident, then you might take high-risk trades.