Risk Management Techniques for Active Traders

Are you looking to reduce your losses while trading?

Then risk management is a skill for active traders like you. 

Risk management is an essential aspect of trading, and risk management techniques act as a safety plan for traders. They help in reducing the amount of money you might lose. Traders can protect their accounts from losing all their money by managing risks.

When traders experience losses, that’s when the risk happens. But if they handle the risk well, they can increase their chances of making money in the market.

You can think of it as a necessary step for successful active trading. Even if a trader has made a lot of money, they could lose it all in just one or two bad trades without good risk management techniques. 

So, how can you develop the best strategies to control the risks of the market? 

In this article, let’s discuss some simple risk management trading techniques to keep your trading profits safe.

What Is Active Trading?

What Is Active Trading?

Source: wallstreetmojo

Active trading refers to quickly buying and selling investments to make a fast profit based on short-term changes in prices. The idea is to only keep the investment for a short time, and there’s no specific time limit for how short.

People who make many trades in a single day, like day traders, are active traders. But even someone who opens or closes positions every few days, like a swing trader, is also considered an active trader by many.

Active traders want to make money by taking advantage of price changes in markets where buying and selling are easy. That’s why they usually focus on things like stocks, foreign currency trades, futures, and options with a lot of trading activity.

To make a profit, active traders make a high number of trades because the price changes in the short term are usually small. They also use different types of orders depending on the situation. 

For example, they might use a stop order to catch a price increase. If there’s a price resistance at 150 INR, they could set a buy-stop order at 150.05 INR. This means that if the price goes beyond 150 INR and reaches 150.05 INR, the order to buy is automatically placed.

They also use stop-loss orders to limit their losses if the price goes against them. To get a good price, they might use limit orders. 

For instance, if a stock is trading at 130 INR, but traders want to buy it at 129.50 INR – then if it quickly drops, they can place a limit buy order at 129.50 INR. Similarly, they can set a limit sell order to sell at 131 INR.

Top Risk Management Techniques for Active Traders

Traders who buy and sell a lot use certain tricks to stay safe. They pick a good broker, think carefully before making decisions, set points to limit losses and lock in profits, spread their bets, invest in different things, and use a strategy called hedging.

Here are the top risk management strategies for active traders – 

Read More: Simple Exit Trading Strategies to Exit Trades Sensibly

Planning Your Trades

Planning is essential in both war and trading. Just as the famous saying goes, “Every battle is won before it is fought,” it means that preparing and strategizing lead to success. This idea also applies to trading, where planning can make a big difference.

  • Start by choosing the right broker for your trading style. Some brokers are better for frequent trading, offering lower fees and tools for active traders. 
  • When it comes to trading itself, set stop-loss (S/L) and take-profit (T/P) points in advance. This means deciding in advance the price at which you’re willing to buy and sell. 

Successful traders calculate potential returns against the likelihood of reaching their goals. If the potential gain is worth it, they make the trade.

On the other hand, unsuccessful traders often jump into trades without a clear plan. Emotions take over, leading to impulsive decisions. Losses may make them hold on, hoping to recover, while profits may tempt them to hold for even more gains, risking imprudent choices.

Set Stop Loss & Take Profit Points

Source:forexnewsnow

One of the popular risk management techniques is stop loss. A stop-loss point is the price at which a trader sells a stock to avoid losing more money. It’s like a safety net to prevent bigger losses when a trade doesn’t go well. It stops the trader from thinking, “Maybe it will get better later,” and helps to control losses. 

For instance, traders often sell quickly if a stock drops below an important support level.

On the flip side, a take-profit point is the price at which a trader sells a stock to make a profit. This happens when the potential for more gains is limited compared to the risks. 

If a stock is getting close to a major resistance level after going up a lot, traders might sell before the stock enters a period of stabilization.

How To More Effectively Set Stop-Loss Points?

Source:elearnmarkets

Deciding when to sell stocks involves two main things – setting points to limit losses (stop-loss) or locking in profits (take-profit). People usually use fancy techniques like technical and fundamental analysis for this, but let’s keep it simple.

Imagine you own some stock, and there’s exciting news about the company’s earnings coming up. If everyone’s getting too hyped up, you might want to sell before the news hits, even if the price hasn’t reached your profit goal.

  • One common method is using moving averages, like the average price over 5, 9, 20, 50, 100, or 200 days. 

These are easy to figure out, and many people watch them. By looking at a stock’s chart, you can see if the price tends to bounce off these averages.

  • Another way is drawing lines on the chart based on previous high or low points with a lot of trading activity. 

These lines help you see where the price might stop (support) or struggle to go beyond (resistance). The key is figuring out when the price reacts to these lines or averages, especially if it happens with lots of trading activity.

When deciding on these points, think about the following important things – 

  • It’s better to use moving averages over a longer period for stocks that go up and down a lot. This helps avoid selling the stock too quickly because the price temporarily decreases.
  • Change the moving averages to fit the desired price ranges. If you have higher target prices, use bigger moving averages to make fewer signals.
  • Change the stop loss based on how much the market is moving. If the stock price isn’t changing a lot, make the stop-loss points closer.
  • Don’t set your stop loss too close; make sure it’s at least 1.5 times the current range of prices. If it’s too close, it might get triggered even if there’s no real reason for it.
  • Pay attention to important events like earnings announcements to decide when to enter or exit a trade. This is because volatility and uncertainty can increase during these times.

Consider the One-Percent Rule

Most day traders follow a simple rule called the one-percent rule. This rule says you should never gamble more than 1% of all your money on just one trade. 

For example, having 10,000 INR doesn’t mean you can only spend 100 INR. It means you shouldn’t lose more than 100 INR in a single investment.

This rule is commonly used by traders with accounts less than 100,000 INR; some may go up to 2% if they can afford it. However, using a smaller percentage is usually safer if your account is larger. Keeping the risk below 2% helps prevent significant losses to your overall trading account.

Diversify and Hedge

To make the most of your trading, don’t put all your money into one thing. This is yet one of the most important risk management techniques traders should follow because – If that one thing goes bad, you could lose a lot. 

Spread your money around different types of investments, like different industries, market sizes, and places in the world. This helps you handle risk better and gives you more chances to make money.

Sometimes, you might want to protect your investment. If you have a stock and important results are coming, you can use options to take the opposite position and keep yourself safe. When things settle down, you can get rid of this protection.

Calculating Expected Return

Deciding when to sell or buy in trading is important. Setting stop-loss (the point where you sell to minimize losses) and take-profit (the point where you sell to lock in profits) helps you figure out how much money you might make. 

This is really crucial because it makes traders carefully plan and think about their trades. It also allows them to compare different trades and choose the ones that make the most money. You can use this formula to calculate this.

[(Probability of Gain) x (Take Profit % Gain)] + [(Probability of Loss) x (Stop-Loss % Loss)]

After this calculation, active traders determine how much money they might make. Then, they compare it to other chances to decide which stocks to buy or sell. 

They can find the likelihood of gaining or losing money by looking at past times when stock prices went up or down from certain levels or by using their experience to make an informed guess.

Downside Put Options

If you can trade options, getting a “protective put” can help prevent big losses if your trade goes bad. With a put option, you have the choice to sell your stock at a set price before the option ends. 

For example, if you bought XYZ stock for 100 INR and got an 80 INR put for 1.00 INR, you’re safe from any price drop below 79 INR (80 INR minus the 1 INR you paid for the option).

The Final Verdict

As the stock market is volatile and offers huge risks, following proper risk management techniques is important to minimize losses and maximize returns.

Among many, these were the top risk management techniques for active traders.

With these strategies, traders should remember to decide when they want to start or stop the trade before taking a trade. Using these risk management strategies and stopping losses smartly helps reduce both losses and unnecessary trade exits. 

So, plan your moves in advance and record your successes and losses.

Besides these risk management strategies, there is more about how to apply these strategies efficiently, which is suitable for your trading style, etc.

If you’re keen to learn more about risk management trading techniques and boost your trading success, explore Upmarket Academy’s trading courses and learn for free.

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