Risk management is very low on priority for most amateur traders and this is the last thing that they want to discuss. Traders spend a lot of time in analyzing how to enter the trades and be profitable and exit the trade. But they spend very less time in understanding how to manage risks, or where to place the stop loss.
It is important to understand the full review that without managing your trades well you will never be able to profit. Risk management is important because it helps the trader to plan his risk before he takes the trade and this, in turn, helps him to size his positions. Ask any professional trader and he will let you know that he has more losing trades than winning trades. It is just that he manages his risk properly and thus eventually ends up in green.
The famous 1% risk rule
This rule as the name states implies that a trader does not take more than 1% risk on his capital on any single trade. This does not mean that you need to buy stocks worth1% of your capital. This means that you need to keep a maximum risk of 1% of your capital on each trade and thus the stop loss on the trade will be less than 1% of your capital.
Why is this rule so popular?
Trading is a game of probability and no one can tell with certainty whether a trade will end up in the profit or not. The 1% rule helps to protect the capital of the trader from declining further in case the stock or the security trading in goes down further in price. Following this rule helps to protect your capital so that you can use it to take another trade.
Stop loss is important because it lets you cut your losses fast and gives you the option to invest in some other trade. Make sure that you do not keep adjusting your stop losses but stick to it. The secret mantra of every successful trader is to cut the losses fast but ride on to the profitable trades for long.
Reward risk ratio
Every trade that you take should meet the reward and risk ratio criteria. This should at least be 2:1 for a day trade and 3:1 for a swing trade. Also, use the trading stop loss technique to ride on to your trade. If the trade is in your favor then you can keep making profits till the trade moves in the opposite direction.