Risk management is key to trading. Every trader makes losing trades sometimes. But good traders respect and manage their risks. You must be able to manage your risk and cut losses so you can continue to trade. Managing risk also means protecting your capital. It’s important to not let a bad trade drain your account. There are several ways to protect your trades from unexpected changes in the market.
What is leveraged trading?
Leveraged trading is making trades in the market using leverage. Leverage is using the borrowed capital to increase your trading exposure. Leveraged trading gives traders a chance to earn more than possible with just the original capital invested, which is usually a small percentage of your full trade value. Leverage trading is great when prices move in your favour. You could end up making heavy losses as well, however, if markets move in the opposite direction.
If you trade using leverage, you can take a small capital and use it to control a bigger sum of an asset. Your profit potential increases if the market changes in your favour. But your loss potential also increases if market prices move in the opposite direction. Be careful when using leverage so as not to increase your risk.
Monitoring your spread
You must know how spreads work to track the potential for risk. Whatever spread betting platform you use, it will offer two prices for your trading instrument. These two prices are the buying price and selling price. Traders buy when they expect market prices to rise and sell when they expect prices to fall. The spread is the difference between the buy price and sell price of an instrument. Brokers wrap their cost in the spread that is offered to you. The wider the spread, the higher the cost of trading. Trading costs will be lower when the spread is lower.
How do stop losses work?
Protect your trade from rapid changes in the market by using stop losses. Stop-loss orders are a handy tool to protect your trades when prices move against you. You can calculate in advance the maximum loss you are willing to take per trade in case prices move in the opposite direction. This will prevent you from losing more money. Stop losses help prevent larger losses from occurring in a quickly changing market. Stop losses are a great tool for risk management. This tool is offered by most trading platforms.
Difference between stop-loss orders and guaranteed stop-loss orders
A stop-loss order does not guarantee that your trade will close out at your pre-set price. So if the price of the market does slip lower than your pre-defined price, you could end up losing more than you expected. Slippage or gapping usually happens when market prices rise or fall suddenly by large amounts. Such sudden price changes are usually caused by unexpected news or market-moving events. Your trade could close out at a worse price. A guaranteed stop-loss order automatically stops your trade at the precise point you have set. This will happen despite any slippage or gapping.
What is a take-profit order?
Take-profit orders work in much the same way as a stop-loss order. The key difference is that a take-profit order automatically stops your trade at a pre-set level to make a profit.
Using a reward:risk ratio
A reward:risk ratio is a great tool for helping to minimise risk. This ratio is a measure of reward versus risk. Using the risk:reward ratio will help you predict your profit for a trade against how much you are content to lose. This amount depends on your personal trading goals and finances.
Calculate your ratio by taking the total potential profit and then dividing it by your total potential loss. If your reward:risk ratio is 1:1, then you must have higher than a 50% rate of profit to make a profit long-term. So you must have a winning trade for every trade you lose.
Use your reward:risk ratio with stop orders to help minimise losses and increase your potential for earning on your trades.