Everything you need to know about risk management
If you have been convinced to give trading a go, then one of the most important processes you will have to get your head around is risk management.
You may well have seen traders living lavish lives on Instagram, driving flash cars and jetting off on holiday whenever it suits.
However, before you start trading forex or anything else it’s important that you get your head around the risks – and what you can do to minimise them, or at least trade within your own boundaries of risk.
What is risk management?
Whether you’re trading stocks, foreign currency or commodities, the same mantra applies to each – you could lose whatever you invest if things don’t pan out as you would like.
Essentially, risk management refers to the amount of money you are prepared to invest and not make back in your attempts to strike on success.
Having a clear risk management plan is essential – especially for beginners – as chasing losses is a sure-fire way to get yourself into bigger problems financially.
How to identify the risks
Your tolerance to risk will depend on all kinds of things, including your income away from investing, whether you have any dependents and more. Here are three ways you can identify and manage risk.
1) Learn from professionals
Finding like-minded people that have made a career out of trading might open the doors for you to find your own success. You may be able to pick up and replicate successful strategies and even partner with those that have carved out a niche for themselves, with many eyes monitoring opportunities as they crop up.
2) Use demo accounts
Most regulated trading platforms will offer a demo account. With this, you can use a virtual pot of cash to execute trades on the platform and get a grip on how quickly markets can move and what you might have to do to become a successful trader. This is a great way for beginners to get a grip on things without losing starting capital.
3) Commit to a risk-management plan
Before you start trading for real, consider and write out a full risk-management plan. Look at what your risks are – be it particular assets you plan to trade or other market-moving events – and outline strategies that you can put in place to minimize them.
Four risk management strategies you can use
There are essentially four categories of risk management. Here are four risk management strategies you can consider.
1) Risk acceptance
Essentially, highlighting risk and opting to do nothing to mitigate it. Some mitigation tactics may cost you more in the long run. So if you can avoid taking this punt, then simply accepting the risks means that you could benefit, but can also cut your losses if things go the other way.
2) Risk transference
Enlisting others to handle risks for you. This term typically applies mostly to the insurance sector. However, many financial advisor firms offer set portfolios in which you can invest – transferring the management of risks to them.
3) Risk avoidance
Eliminating the chances of risk. For example, if you deem an investment to be more likely to lose your money, you can simply keep hold of your cash and live to fight another day!
4) Risk reduction
Say that same investment shows signs of life further down the line but you’re still not convinced, investing at a reduced rate than you would have otherwise means you can keep hold of some capital for other uses, while a smaller portion of your portfolio is put at risk.