Risk Management in Trading – A Brief Guide for Beginners

An important thing to know about trading is that it is not without risks. It doesn’t matter how careful you are, your investments are always subjected to some amount of risk. This is why traders use trading risk management tools to avoid losses.

Having an effective risk management plan helps you to identify potential risks and find out ways to avoid them. Additionally, risk management helps you to maintain emotional stability and stop you from making impulsive choices.

If you are planning to venture into the financial markets, make sure to prepare a proper risk management strategy. This will protect you from suffering major losses. To know more about this topic, you should give this post a read.

Important Risk Management Techniques

Even if you are an experienced trader, you shouldn’t venture into the trading market without a proper risk management plan. Due to high volatility, the market tends to change often. This means, anything can happen any time and you need to be prepared to handle it.

Here are some risk management techniques that you may find helpful:

Diversification

One of the most effective ways to curb trading risks is to diversify your investments. Instead of putting your money in one place, you should spread it on various assets. This way you can avoid any significant losses from happening.

This technique is followed by both seasoned and amateur traders. So, if you are new to the market, make sure to diversify your capital.

Position Sizing

To put it in simple words, position sizing ensures that the impact of a single investment is limited on the overall portfolio. By following this technique, you can control the risks involved in an effective manner.

Position sizing allows you to define your investments at risk at any given position. In other words, you can set the limit to a certain percentage of your total investment.

Portfolio Optimisation

This is another technique followed by traders to mitigate risks in the financial markets. By optimising your portfolio, you can maximise the expected return on your investments. 

To go about this technique, you need to analyse your portfolio with different proportions of your capital. This can be done by evaluating the return and risks involved for each portfolio and choosing a combination of investments that will help you to achieve the desired trade.

Hedging

This particular technique is used to offset a potential loss. By hedging against market value, you can protect your investments from major price fluctuations. This can be done with the help of offsetting contracts against the position held while hedging against credit risk.

In most cases, the relationship between derivatives and hedging is defined clearly. This means, you can use the derivatives for hedging. You can also use other financial tools like future contracts, options, swaps, and insurance to hedge.

By following these techniques, it is possible to manage risk while trading. Even if you fail to prevent a loss, it will at least ensure that it is nothing major.