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Risk Management vs. Money Management
Risk Management vs. Money Management

To not be able to apply risk and money management principles is most certainly very much disadvantageous to traders. To better understand this point, let us first define what Risk Management and Money Management are, respectively. By assessing market conditions, risk-reward ratios, probabilities, and the use of stop loss orders, and many others, Risk Management aims to minimize the losses for every trade. On the other hand, Money Management focuses on the steps necessary to maximize profit by the use of trailing stops and adjusting the transaction size, and many more.
What is your attitude toward risks?

Your attitude toward risks will affect how you trade. It is very important that your attitude toward risks be well-suited to your personal style as a trader. It is important to note that the longer you stay in the market, the higher the chances of risk becomes. With this being said, the trading approach which keeps you in the market for the longest amount of time is said to be the riskiest. This is why it is crucial to determine how you react toward risks. Are you a risk-taker, or are you risk averse?

Over-all, what is the risk in the market?

It is imperative that you make your mind up regarding the maximum amount of capital you are willing to place at risk at any given one time. You have to be prepared for the worst case scenarios. If the market crashes again, just like during 9/11, a catastrophic loss could come from having a very big percentage of your equity in the market. Most traders choose to just risk 1% on any one trade. This is while having a maximum exposure of 5% in total in all open trades. It is the lesser evil since even if you will still be losing the 5%, it will not be as horrific as losing way more than that.

How do you control Sector Risk exposure?

To control the sector risk, you have to limit the number of open positions in one sector.

How will you deal with Broker and Hardware Risk?

If your broker folds and you have no way of closing your open positions, what will you do? Suppose your PC or mobile device crashes and you need to take action on your position, what will you do? As a trader, you have to come up with possible ways to resolve these kinds of random problems when they suddenly arise. This is why you should put this in your Trading Battle Plan. It is never enough to just have a Plan A. There should always be a Plan B, C, D, and so on.

What is the Strategy Risk?

Always remember that the markets are ever-changing. A tried and tested trading strategy of yours may have been profitable last year or even last month, but now, there is always a possibility that your strategy may be disprove. What you can do in the event your trading strategy seems to have stopped working already is to measure the largest % draw-down on each trading strategy being used. After getting the % draw-down, multiply it by a factor of 1.5 to 2. Once you get the answer, check If the draw-down goes over this figure. If this occurs, STOP using the trading strategy!
How high are your chances of a profitable trade?

In the aspect of evaluating the specific risks involved with a proposed trade, a lot of traders only focus on the ratio of risk-reward. However, this piece of information is deemed to be pointless if you do not include probability in the equation. In order to evaluate the probability of success of a particular trading strategy, we must begin by properly setting an accurate, straight-forward definition for the trade setup. This is crucial to be able to spot the trade setup trading with real money on a real-time basis. Afterwards, if the setup had already been given precise definition, it must undergo a series of tests to check if the probability of success is far greater than that of failure. This is often termed as ‘Success Ratio’. To get this ratio, you must divide the total number of trades that were positively profitable by the total number of trades made. Then, get the percentage by multiplying the answer by 100. The answer is your success ratio. 

What is Risk-Reward ratio?

So we can find out the Risk-Reward ratio, we must first know the success ratio, which had been discussed in 10.7., and the Sharpe ratio which is the average amount of money made on profitable trades relative to the average amount of money lost on the others. To compute for the risk-reward ratio, simply divide the average amount of money gained on profitable trades by the combined figures of the average amount of money gained and lost, then multiply by 100.

What is your risk per trade?

Even if you can forecast the direction the market will take 99% of the time, this will be meaningless if you risk 100% of your capital on every single trade. Yes, you could accumulate a fortune; however, the chance that one day you will lose everything is terrifyingly high. Most traders will never end up risking more than 1% of their capital at any given one time. 

Why should you place your Stop Loss orders?

Unless you are an experienced trading expert, you must always ensure that you set up a stop loss for every trade. By doing so, you will have a guarantee that all losses will be cut short depending on the parameters you set for your stop loss. You must also vary the number of shares or contracts to make certain that you remain within the risk per trade parameters defined in 10.9.

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