Risk Management Basics

Why it is important

There is no way to avoid risk in total because every trade could become a loss. It is important to recognize that many people can lose money on trades more often than they make money and still increase overall account value in the long run if the gains on winning trades far exceeds the losses on their losers. While someone else may win on a majority of their trades, and still lose money over time by taking small gains and big losses.

Possible Techniques

W/L Ratio

Determine your win loss ratio, and the average size of your wins and losses. If this number winds up being positive you are fine however if you don't know your ratio you are putting your trading account at risk. Your broker should automatically calculate your W/L ratio however if not just use the fraction normally.

Keep your strategy unemotional

This is usually the hardest part. You need to be able to take the losses when the trading system tells you that you are wrong, and also be able to cash out on your winds for a false hope of larger profits. Don't be greedy, bulls and bears survive, pigs get slaughtered.

Whenever you change your system, follow the rules of that system. Get in when it says and get out when it says, second guessing a system and freestyling is a very risky practice.

Risk to Reward Ratio

It is a type of cost-benefit analysis based on the expected returns of an investment compared to the amount of risk taken on to earn those returns. TradingView has a built-in RRR as follows: 1st click on the measurement tools and choose either short or long position depending on what you are doing.

Next press wherever you will be making that trade. You can drag your take profit levels up or down as well as your stop loss. When you do this next to the TP and the SL a percentage of possible win or loss will be shown. As well in the middle there will be a number showing the ratio. Here is an example below.

On the top it says "target" which is the price I will get out of with the percentage of possible profit next to it. The same concept is "stop" which is the value at which I will leave and how much I could lose

Here is how to manually calculate it:

1. Determine your entry price: The price at which you plan to enter the trade or investment.
2. Determine your stop loss price: The price at which you plan to exit the trade if it moves against you. This is the maximum amount you are willing to risk on the trade.
3. Determine your target price: The price at which you plan to exit the trade if it moves in your favor. This is the profit target you are aiming for.
4. Calculate the potential reward: To calculate the potential reward, subtract your entry price from your target price. For example, if you plan to buy a stock at $50 and your target price is $60, your potential reward is $10 per share.
5. Calculate the potential risk: To calculate the potential risk, subtract your stop loss price from your entry price. For example, if you plan to buy a stock at $50 and your stop loss price is $45, your potential risk is $5 per share.
6. Calculate the risk to reward ratio: To calculate the risk to reward ratio, divide the potential reward by the potential risk. For example, if your potential reward is $10 per share and your potential risk is $5 per share, your risk to reward ratio is 2:1.

A good rule of thumb is to aim for a risk to reward ratio of at least 1:2, meaning that the potential reward is at least twice as large as the potential risk. This helps to ensure that your winning trades will more than make up for your losing trades over the long run.

Hedging Your Trade

Hedging is when you buy offsetting positions that make money when the main investment experiences losses. Normally this is done with different options strategies built for hedging however that will be in a later article. One of the most common ways is to buy a gov. bond etf of some sort that makes money inverse to the market.

Portfolio Diversification

Portfolio diversification is owning non-correlated securities so overall risk is reduced without sacrificing returns. Here are some strategies:

1. Invest in a mix of stocks: One of the simplest ways to diversify your stock holdings is to invest in a mix of stocks from different sectors and industries. For example, you could invest in a combination of technology, healthcare, financial, and consumer stocks to spread your risk across different sectors.
2. Consider investing in index funds or ETFs: Index funds and ETFs are designed to track the performance of a specific index, such as the S&P 500 or the NASDAQ. By investing in these funds, you can gain exposure to a wide range of stocks and spread your risk across different sectors and industries.
3. Invest in international stocks: Investing in stocks from different countries can help to diversify your portfolio and reduce your exposure to any one particular market. For example, you could invest in emerging market stocks, which offer higher growth potential but also higher risk, or developed market stocks, which are generally considered to be more stable.
4. Rebalance your portfolio regularly: As your investments grow and change over time, it's important to rebalance your portfolio to maintain your desired level of diversification. This may involve selling stocks that have become overvalued and reinvesting the proceeds in other assets, or adding new investments to address any gaps in your portfolio.