Beginner's Guide to Risk Management - How can I Maximize Gains and Minimize Losses?

-Rajiv Bhandari

Risk Management has always been a crucial part of trading. Successful trading is not only dependent on the right prediction of the trend but also on the management of risks. Risk Management is a must-have strategy for a successful, long term trading career. In the absence of good risk management skills, many good traders lose their profit and even their capital.

Risk management may not be a topic of interest for novice traders because it does not secure the return but restricts the loss. But exiting the market by avoiding loss is also gain. Novice traders are always in search of the holy grail factor which will always give them gains on every trade they enter. They focus on maximization of profit rather than minimization of loss. In expectation of high profit, they take higher risk, way out of their risk appetite.

Researches say that after 8 trades there is the major chance of 3 continuous loss, after 16 trade there is a chance of 4 continuous loss and after 32 trade there is a chance of 5 continuous loss. So risk management is as important as market analysis and placing the right trade. A series of right trades may turn sour without a good risk managing strategy.

A trader should enter into the trade by being mentally, emotionally, and economically aware of the possibility of loss. A trader should never ignore the possibility of loss. The market is mechanized in a way that most of the traders lose and only a few win. Trading overall is a negative-sum game, winner wins less than that the loser loses because of several factors such as brokerage, taxes, and other fees.

Experts say even a very successful trader has a hit rate of 60% to 70%. This simply means that successful traders also lose 30% to 40% of the time. But the question is, how are they successful even after losing 40% of trades?

The answer to this is simple: they are successful risk managers. They limit their risk size. This makes their loss smaller. The series of larger gain and smaller loss finally leads towards successful trading. Walking five steps forward and 3 steps backward finally take a person two steps forward. This is the secret mantra of successful trading. We cannot expect to move five steps forward only.

Risk management starts before trading. At first, a certain amount should be set aside as trading capital out of disposable income or savings. No trader should start with undecided capital. Starting without deciding on the exact amount of trading capital may lead to the injection of a higher percentage of wealth into trading, the loss of which may lead to the loss of a higher portion of wealth.

No trader should begin their trading journey with a loan amount. Loss of borrowed amount may lead to bankruptcy. If a trader enters with a trading capital of Rs 1,00,000 then it can be from his savings or he may gradually plan to increase his trading capital to such an amount by contributing from his monthly disposable income. The capital may be dynamic. After a profit, a trader may increase his capital.

Another aspect of risk management includes trading limits. A trader should not trade his entire trading capital in a single trade. Diversification of funds is a must. There is a common practice throughout the world that at most 10%-15% of trading capital should be invested in a single trade. According to this strategy, if the trading capital of a trader is Rs 1,00,000, the trader can invest no more than Rs 15,000 in one trade. A trader may modify this strategy after he gets comfortable in his strategy. Nonetheless, for a novice trader, risking it all on a single trade is counterproductive.

Risk-taking is another thing involved in risk management. A trader should not risk more than 2% of his trading capital in a single trade. Commonly experts suggest having a 1% risk on the overall capital but if the trader is confident on his trade and his indicator is giving a positive indication then he can take a 2% risk at most.

To sum up the points, risk management is a must-have tool for a successful trading career. Stock traders should start after properly deciding on their trading capital and risk tolerance. Risk tolerance may differ from one to another person. It is affected by the income of the trader, investment objective, investment experience, and many other factors. A trader should constantly try to enrich himself with knowledge. In other words, learning never stops for a consistently profitable trader. Knowledge is the greatest asset in the field of trading. Knowledge attracts money, and money attracts the ability to acquire more knowledge. This cycle perpetuates in the world of trading.

Happy Trading!!

Disclaimer: This is an opinion piece. The author takes full credit and responsibility for the views presented. Sharesansar as an entity does not endorse an investment strategy over another. Financial markets are prone to unexpected losses. Reader discretion advised.