Peri Kaufman’s book “Systems and Methods of Stock Trading” provides basic tips for reducing risk:
1. Do not keep the position open longer than necessary. If you hold a position for a long time, you expose it to all possible risks.
2. Try to earn the maximum possible with minimal investment.
There are also common sense risk management strategies:
1. Risk only a small share of the total capital in a single transaction.
2. Set the exit conditions in advance.
3. A large profit means a large risk.
4. Exit the transaction quickly.
5. Do not allow margin requirements to appear (in case of a sharp decrease in your account during the transaction, the broker may ask you to add money to the account or forcibly reduce your position by selling part of the assets at the market price).
6. When selling part of the position, first close the worst deal.
7. Do not deviate from your trading algorithm (more on this later).
8. Make sure that your trading profile matches your risk appetite.
9. Have an emergency plan in place.
One of the ways to manage risk is to choose the type of trading: long-term, medium-term or short-term.
Long-term. This strategy is used by strategic investors and semi-professional speculators. It is most effective with an emerging trend and least profitable with sideways or sluggish trends. It requires mandatory insurance and appropriate work on the futures exchange options market.
Medium-term. This strategy is also mainly used by semi-professional speculators. This strategy can take advantage of all work strategies, on the one hand it can be quite long-term, and on the other – quite short-term. A safety net in the options market is also desirable.
Short-term. It is used by professional players who already know and “feel” the market well enough. The positive point here is the fact that using this strategy of work you do not expose yourself to the risk of unexpected messages and price changes at a time when you were not on the market. Negative – high indirect costs (commission, spread, communication services, etc.); greater risk of adverse short-term price fluctuations; requires constant concentration, tension and control throughout the working day.
Another type of risk management is averaging, which consists in increasing your position at a more attractive price if the price movement has gone against you. Thus, you are improving your position in terms of price, but you are putting more and more money into the deal. With a poor understanding of the price movement scenario, such a strategy can drain all your money out of you and lead to significant losses. However, in some cases, such a strategy can give unexpectedly high profits, because the volume of lots in your transaction can be very large. We strongly recommend using averaging only if you have at least 3 years of trading experience in the Russian market.
The basis of risk management, in our opinion, is the knowledge of the trader when he should close a deal. Let’s explain.
If you use stop-loss orders (about them below), then when the price moves against you, the broker will close your deal automatically when the conditions of your order are met.
Now imagine that the price has risen above the price you expected and continues to go up. In this case, you can either close the position with a take profit, for example, using a 3:1 risk, or continue to hold the position, being ready to close the position manually at the appropriate moment. We believe that in this case, the best option would be to set a stop order near the current price and move the stop order manually following the price movement. In case of an unexpected movement in the opposite direction, the application will have time to work, and you will receive your profit.
The well-known trader Alexander Rezvyakov uses in his practice the use of the current profit on an open transaction to sit out the reverse price movement, which allows, if the price movement is correctly determined, to remove the entire half-wave organized by the market maker.
Also, the basis of risk management is the part of the funds available to you for trading that you use in the transaction. The approach here may also be different. According to the axioms of the stock speculator M. Gunther, you should use no more than half of the money you have as much as possible. Larry Williams mentions only 2%, P. Kaufman calls 5%. Obviously, this threshold is determined by the size of your amount. If you make a deal for 10,000 rubles, then you can afford to use 100% of this amount, because for 1% of the profit it will be only 100 rubles. However, if you have $ 200,000, then the risk of 2-5% is most likely justified for such an amount, i.e. $ 4,000 – $ 10,000.
On the Internet, you can find materials showing how traders manage to disperse an account of $ 10 to $ 1000 on the BINANCE exchange using huge shoulders – 50x or even 150x, i.e. operating with amounts from $ 500 to $ 1500, having only $ 10 in their pocket. The risk in such transactions is incredibly high and can liquidate your account in a fraction of a second.
From the author, I note that we recommend using no more than 30% of your account in transactions. With insignificant amounts, this will allow you to trade even with shoulders up to 10x. We recommend keeping the minimum size of your account at least $20. Risk management is further discussed in detail in our book.