(Newswire.net — August 27, 2021) — Risk management is your safety net. It cuts down the losses and protects your trading account from losing all the money. However, you are always at risk with trading, and it is critical to safeguard against future losses by protecting your assets. Always remember that even the most diverse and carefully built portfolio can get obliterated by a couple of bad trades.
According to expert trader and risk management specialist Peter DeCaprio, you need a set of strategies to minimize your risks with trading. Here is all the information you ever needed.
The one-percent rule
Most traders follow the one-percent rule, which states that it is good to never put more than 1% of your net capital into a single trade. It is a cliched rule, but that doesn’t make it any less pertinent. Yes, you can trade as high as 2%, but stick to the basics to keep the losses in check, especially if you are a beginner. To minimize risking a substantial amount, stay true to the rule and always invest below 2%, strictly.
About the stop-loss margin
Every trader operates within the stop-loss margins. However, while devising your stop-loss, consider the following.
- Meaningless price swings for volatile stocks can trigger stop-loss – reduce the effect by using long-term moving averages.
- Adjust your moving average to match the target price range constantly.
- Adjust your stop-loss margin to 1.5 times the real-time high-low or the overall volatility.
- Constantly adjust the stop-loss as close to the market volatility.
- Target the fundamental events like earnings release and similar to cash in or out of a trade.
The expected return
Stop-loss and take-profit allow you to calculate the expected return. Calculating the expected return enables you to rationalize a trade. If it fails short, then it is a bad trade. It is the only system to compare trades and select the right one. The formula for calculating the expected return is.
(Probability Gain) x (Profit % Gain) + (ProbabilityLoss) x (Stop-Loss % Loss)
Diversification and Hedging
Diversification allows you to avoid the amateur mistake of putting all the proverbial eggs in one basket, says Peter DeCaprio. The biggest mistake you can make while trading is putting all your money in one stock which is the surest way to a backbreaking loss. Continuously diversify your portfolio not just across industry sectors but geographic locations and market capitalizations. Remember, it is not just about the risk but increasing your trading opportunities as well. You can also choose to hedge your position. Consider the stock position, then wind or unwind a hedge position, as is necessary.
Downside put
You can buy a downside or a protective option if you have approval for options trading. Keep in mind a downside put is a great way to stem the losses from a bad trade. Simply put, this option allows you to sell the stock at a specified price before the option expires. It protects against market fluctuations and sudden drops if done right.