The Psychology of trading with risk management practices

Risk management practices can be powerful for those who learned to trade through diligence and perseverance, but they also offer value to those who were born to trade with instinctual clarity. Risk management allows traders to capitalize on economic trends while reducing the trading risk of major losses.

When the value of your hard-earned money is at the mercy of inflation, Exness offers a gateway to not just preserve but also cultivate your equity. Online trading has emerged as a beacon for savvy investors looking to navigate the turbulent tides of the global economy. But to trade better, one must not only have access to the right tools but also the wisdom to use them. That’s where risk management becomes your ally in the quest for enhanced trading performance.

Position sizing

Mastering position sizing ensures you're never overexposed on a trade. It's the savvy trader's method to manage potential losses while aiming for optimal gains. It’s about determining the volume of a trade. Rather than a one-size-fits-all approach, you calibrate the size of your position based on the specific risk you’re willing to take for each trade.

Let's say you have a $1000 trading account. Adopting a 1% risk management plan per trade policy means you’re risking $10 on any single move. This size ensures that if the stop-loss is triggered, you only lose $10, exactly 1% of your account, safeguarding your capital from a significant drawdown.

Position sizing isn't just about minimizing risk—it's about optimizing your potential for profitability. By scaling your trades to the appropriate size, you maintain control over your portfolio's exposure to market movements, whether you're dealing with stocks, forex, or any other asset. This approach enables you to weather the storms of volatility and stay in the active for the long haul.

Stop loss and take profit orders

If you ever want to get a good night’s sleep while orders stay at work, Stop Loss (SL) and Take Profit (TP) are a must-have.

Stop losses, even when you are not online

Set an SL to automatically exit a position at a pre-determined price, minimizing potential losses. For stocks, place SL just below key support levels or use a fixed percentage of your entry price. In Forex, base your SL on currency volatility. Consider using the Average True Range (ATR) indicator for guidance.

Use take profit to catch those perfect exits

TP orders lock in your gains by selling once your profit target is reached. For stocks, one popular strategy is to aim near historical peaks or set a goal within that range. For Forex and commodities, align TP with pivotal market levels or a favorable risk/reward ratio.

Calculating the perfect spots for SL and TP is straightforward. Use a fixed percentage of your investment to define the SL and set the TP at a point that offers a risk/reward ratio that matches your strategy, like 1:2. For instance, in a Forex trade, if you have $10,000 and don’t want to risk more than 1%, you'd set SL 50 pips away with a $2 value per pip. This sets you up for a potential $200 gain if your TP is 100 pips away.

Adapt these practices to fit the unique volatility of the assets you trade, and remember, regular strategy refinement based on market trends and your personal experience is key to ongoing advancement.

Risk/reward ratio

This is the balance scale of trading, comparing what you're willing to lose (risk) against what you aim to gain (reward). It's a critical metric that guides traders in identifying positions that are likely to be profitable.

Assuming you're eyeing a stock at $50, foreseeing a rise. You might set a stop-loss at $45 to protect against a drop — that's a $5 risk. You anticipate the stock could rise to $60, a potential $10 gain. This gives you a risk/reward ratio of 1:2 — for every dollar at risk, you expect to double your potential reward.

Strategy benefits

By seeking trades with a favorable risk/reward ratio, such as 1:2 or higher, you position yourself in scenarios where the gains can more than make up for the losses. Even if not all trades are positive, those with higher reward potential can offset the losses and lead to an overall profitable trading strategy.

This ratio is a cornerstone of disciplined trading, ensuring that your trades are not just guesses but rather calculated risks. With a solid risk management plan, you can approach the markets with confidence, knowing your strategy aims for sustainability and growth.

Conclusion

As with many trading psychology practices, it’s too easy to break a risk management strategy. Many traders will increase the level of risk when their analysis seems bulletproof. Nothing is certain in the markets, ever, so don’t let enthusiasm or confidence dictate your trading practices.

If you break your own rules, be sure to add it to your trading journal with your justifications and report your results after exiting the position. After a few entries, you might see a pattern. If you are one of the lucky few who were born to trade, that pattern might be a positive point of pride. If not, learn from the lessons and trade wiser in the future.

This is not investment advice. Past performance is not an indication of future results. Your capital is at risk, please trade responsibly.

---

Author:

Paul Reid

Paul Reid is a financial journalist dedicated to uncovering hidden fundamental connections that can give traders an advantage. Focusing primarily on the stock market, Paul's instincts for identifying major company shifts is well established from following the financial markets for over a decade.