Risk is there in every business and proper risk management is road to success for any business. Equity trading is a lucrative business which is very rewarding but this reward is not risk free, as theoretically and practically risk free trade does not exist. Because risk is associated with
the reward, it becomes essential to manage risk in order to protect one’s capital.
Risk management is very essential for trading as markets have potential to take back all lifetime profits in just few bad trades. Risk managements help in preserving initial capital and accumulated profits so that one can stay alive long enough in financial markets for wealth creation, thus it provides biggest edge in trading.
Components of risk management
Stop loss is an integral part of risk management. Stop loss is an order placed to buy or sell security once certain price is reached. It is basically designed to limit the amount of loss on buy/sell position. In fact by placing the stop loss one is just closing the losing position and limiting the amount of loss which can increase beyond imagination.
Analyze reward risk ratio
Before initiating a trade, the trade should analyze reward risk ratio. On a conservative basis if the said ratio is less than 1.5 then one should not initiate the trade.
Trail stop loss
Initially stop loss is placed to protect one’s capital on a losing trade, but once the trade is in profit stop loss should be so moved that trade is at zero risk even if trailed stop loss gets triggered.
Profit is the only goal for which we all trade. But at the same time profit is profit only when it is realized otherwise its notional profit. Hence one should book profit at predefined target levels and one should not be carried away by one’s emotions specially greed when prices are near to predefined target levels.
Use of stop loss
A trader should always put Stop Loss and trade a fraction of his capital. It is very important for the trader to have sound knowledge in the area concerned and should be comfortable with the trading system. He should be aware that it is possible and inevitable to have a losing streak of five losses in a row. This is called drawdown. This awareness will help the traders prepare as to how to control risk and choose their trading system.