Risk management involves calculating how much risk you are prepared to tolerate in order to make a profit
For a more detailed look at Risk and Risk Management tools please refer back to the “Risk” Module
When trading it is important that traders realise the importance of Risk Management; it teaches you to pace yourself, to think clearly, and most of all, it helps keep your emotions under control.
Here are a few things you should think about when trading
Trade size – Start with small trades
When you take a hot bath, you don’t just jump in straight away; you test the water temperature with your toes first. Trading is no different. Never jump into the market with your entire position. Test the market first with a smaller trade before taking your full position
Trade sizes that are too large for your account can cause exaggerated price swings and play havoc with your account as well as your emotions. This can then lead to mistakes caused by fear or greed. Like we said before trading affects psychology as much as psychology affects trading
Do not forget that a trade can go wrong – if you are dreaming of a huge profit by taking a large trade size, remember this high risk trade can also produce a loss as big as the profit you were dreaming of.
Aim for at least a 3-1 or at worst a 2-1 Profit/Loss ratio
Planning your risk/reward ratio means that you can prepare yourself mentally for the loss that you might face and prevent emotional trades.
One wrong emotional trade can produce a large enough loss to wipe out the profit of many profitable trades
Once you reach this target you should stop trading so as to avoid giving profits back to the market
P/L targets help to avoid fear and greed compelling you to overtrade and/or increase your trade size
Some times of day are more volatile than others:
Afternoon in London, which corresponds to morning in New York, is the most volatile time of day for most markets, with the largest price swings and profit potential and losses.
During periods of extreme volatility it is usually best to stand aside if you are not an experienced trader.