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Whether you’re a professional trader or someone who dives into trading charts as a side hustle, effective risk management is one of the key factors to trading success.
Many trading platforms provide useful tools to help you manage risk, but it is also important to employ your own tactics in an attempt to limit your losses and trade as profitably as possible.
What is risk management in investing?
Risk management is the process of weighing up your potential profits and losses in any given trade while analysing the likelihood of how factors such as volatility will affect your market.
Different traders will have varying appetites for risk. Some may seek to profit from the short-term rise and fall of more volatile markets while others may seek longer-term trades and outcomes.
Either way, setting clear financial goals from your trading can help you determine what your appetite for risk is.
Risk-management strategies
Practically managing your risk in trading is achievable in many different ways. While some approaches may limit your ability to bank big profits from a trade, they may help you to roll smaller profits into larger overall sums.
Acceptance
Quite simply, accepting that your trade will be open to an element of risk is a way of understanding and mitigating your loss-making potential overall.
Many risk-management strategies involve spending in other areas to mitigate potential losses – increasing your outlay and reducing margins in the process.
If the costs of managing your risk will exceed the value of the investment, it may be worth your while to simply accept the risk and see how it plays out.
Avoidance
Avoiding the risk entirely – keeping hold of your money and opting against a trade – is a viable option when you are uncertain about the future prospects of an investment.
Are you finding it difficult to undertake a detailed fundamental analysis? Are technical indicators displaying a period of extreme volatility? If you’re unable to execute a trade in familiar circumstances, it may be safest to simply move on to something else.
Hedging
A method of risk reduction. Taking multiple positions on one trade gives you the opportunity to profit if markets move both up and down.
It’s important to properly calculate your hedge to ensure that you do stand to profit either way. A miscalculation may mean that the opposite is true and you will not stand to profit at all.
Transference
Transferring the risk to another party enables you to leverage experts in an attempt to profit.
For example, managed portfolio services take the stress and effort out of managing a portfolio of investments, therefore transferring the responsibility for mitigating risk to the third party.
Diversification
Putting all your eggs in one basket is a risky approach to investing. One wrong decision and you could lose your upfront capital, and potentially more besides.
Diversifying your approach to trades, the markets you invest in and the instruments that you use ensures a varied approach to your portfolio and is a smart way of mitigating the individual risks that each trade poses.
