Even the basic knowledge of risk management methods may significantly contribute to the efficiency of your trading
Every investment is subject to risk due to potential unfavourable price changes. As the financial markets constitute a complex system with many factors influencing the demand and supply at the same time, it is important to know that the result of practically any given transaction is uncertain. The factors influencing the market prices are covered in the fundamental analysis section of our website.
Risk management depends very much on the types of assets the trader is interested in. In this text we would like to discuss the tools that can be used in order to minimise potential losses resulting from adverse price changes:
Study the different types of assets: It is crucial to first understand the liquidity involved with the different currency pairs Depending on the type of asset you are interested in, there may be more or less volatility related. The higher the volatility, the higher the financial risk associated with the given market. This means that operating on a such market involves potentially higher profits and losses than in the case of markets with lower volatility. There are markets where there is not much movement, while others change very often and the price changes may be quite significant.Another important issue is the spread - i.e. the difference between the ask price and bid price. Different assets have different spreads, as the spread size depends on such factors as liquidity of the market, its volatility or time of the day. As the spread represents an indirect cost of the transaction for a trader, it can be related to the volatility in order to compare the cost of transaction between the given markets. For example, the cost of operating on a market where the spread is 4 points and the difference between daily maximum and minimum is equal to 60 points, can be considered to be more attractive than in the case of a market where the spread is 2 points, but the daily price range is just 20 points.
Plan your strategy: It is imperative to decide what type of investment strategy is to be implemented The strategy shall define the key aspects of the trades, including their time horizon. There are assets where it is difficult to trade in the short term, as the cost of transaction is relatively high in relation to the size of typical price movements. However, it is still possible to consider such markets for the purposes of investment in the longer term, cost carry transactions or possible arbitrage. On the other hand, assets that change very often could provide a good possibility for transactions in the short and ultra short term.
Establish the maximum acceptable risk for an investment or trade: Important step that many investors seem to ignore It may be a good idea to establish a maximum amount of money that he/she is willing to risk in any given transaction. Such an amount can be defined as a percentage of the available capital. Considering an example where the trader is willing to risk no more than 3% of the portfolio, 3% of that amount would mean that the investor is willing to “risk” no more than $300 USD in a trade.The limit calculated as shown above, or using any other method, can be taken into account when considering where to set the stop loss or close the transaction by any other means. In order to do that, one should also consider a value of pips. Assuming that for a specific asset the pips value is equal to $10 USD, and the acceptable risk is $300 USD, then a trader may consider placing a stop-loss with a value of 300/10 = 30 pips from the level where the transaction was opened.
Use the different orders available on the MetaTrader 4 platform: Understanding the possibilities behind the pending orders of the trading platform may contribute to more efficient trading plan There are many different orders available at the MT5, which can potentially help to realise profits or limit the losses during the investment process:
- Market orders - buy/sell
- Stop loss
- Take profit