Not everyone realizes the importance of trading money management. This is especially true for novice traders who are more concerned about the bottom line. They are mainly interested in making money. Like every other major undertaking though, this usually involves following a process.
In trading the process you would have to apply is your personal plan or system. A good plan often involves paying attention to the sizable section of controlling risks. Before you can successfully do so, you need to steer clear of common mistakes.
#1- Not being able to determine risk limits.
Some people can take higher degrees of pain than others. The same can be said about risk. Some are better able to take high risks than others. This is a crucial fact to remember in trading because it is just not enough to say that you know that risks are involved. A proper risk management system states the exact loss that you can endure. This means you always know before you make any trades how much trading capital you might lose in case a trade doesn’t work in your favor.
#2- Not specifying a stop order.
You can easily indicate how much you are willing to lose. You have to take one step further though to ensure that you only really suffer bearable losses. A good way to keep you out of hot water at the right time is to use stop orders. When prices start to go the other way, a stop order can give you a profitable way out.
This part of trading risk management has two major types. One type that you might want to pay more attention to is trailing stops. If price rises, your stop order will rise too. It only stays put if price drops. Hence, you only exit when price drops below your trailing stop. Since you’ve already piggybacked on the previous rise, you’ll have a tidy profit to collect after you exit.
#3- Indicating maximum loss that is too low or too high.
Maximum loss is obviously a necessary part of any risk control plan. Those who want to stay extra safe may choose to go for no more than 1%. On the other end of the spectrum are the extreme risk takers who may peg maximum loss at 5%. Managing risk too tightly isn’t good because you will lose out on profit potential. Clearly though, it is also a bad idea to risk too much since you might end up eroding your trading float. Settle for a maximum loss of about 2%.
#4- Allocating trading capital for different uses.
Trading is just like a business venture. You need to know from the very beginning how much capital you have available. This is to make sure you only stay within the limits of what you can afford to trade. Some expert traders who opt to diversify their investments may set aside a general trading float. It is often a good idea though to first allocate your resources for one market. This will prevent losses stemming from lack of market specific knowledge.
Creating a risk management system is not something you can leave for later. This is perhaps the biggest mistake you can ever make. Secure yourself from severe losses by giving due attention to this aspect of your trading system.
