Why Risk Management is Important When Trading?
What if you don't have any risk management plan while trading? Is there any hope to earn more without having a risk management plan? Why do all of the experts recommend paying more attention to risk management for beginners? All of these questions pop up in our minds when we start trading.
We all know that risk is always there in the market, but managing the risk is one of the tacky tasks. Risk management is a common term used by traders in the market.
If you have enrolled yourself in any trading course, then you might have listened to this term thousands of times during the course. Because risk management is what is taught more in trading tutorials and courses. They encourage students to manage their risks properly while trading.
Why risk management is vital?
But why does the whole market talk too much about risk management? Why is it important and why should you start paying attention to it? We are here to help you get answers to all of the questions related to risk management and its importance.
Also, we will let you know how you can manage the risk for your trading journey. No matter which market you are in and what assets you trade, we are always here to help you with it. The instructions and information about risk management that we are going to present here, will be useful for all of the market traders.
What Is Risk Management?
The first question is what is risk management. We all know that whenever there is a chance of losing funds, we call it risk. And what if we manage the risk? What if we can control the chance of losing funds?
Yes, the process of managing your risk is known as risk management. It is not a typical term used only in trading. But in other segments of life, we also use risk management terms. We have to manage the risk everywhere.
Whenever we are not capable of killing the risk completely or end up without any risk, we start managing it at a low level. So reducing the chances of more risk is also known as risk management. There are various tactics used by the traders to manage the risk.
Other Terms Related To Risk
Other than risk and its management, there are some other terms related to it. These terms are also frequently used in the trading sector. From beginners to advanced traders, everybody is using these terms. No worries, if you haven’t yet listened to these terms.
Maybe these terms are new to you but the meaning of these terms is not new for any trader out there in the global market. Following are some of these common terms.
Risk tolerance is used for two different purposes. Firstly it is used for a group of traders to indicate how much risk a trader or a group of traders can handle in actuality. Most of the time this term is used in percentage. For example, generally, a trader has approximately 10% to 20% risk tolerance (According to the example given here only).
So the percentage number which shows the risk which can be easily tolerated is known as risk tolerance. Secondly, the term risk tolerance is also used for fund management companies and stocks.
On the other hand Risk Appetite is also a term related to risk which is similar to risk tolerance. This term is also used in a similar way the risk tolerance is used. Stocks, currency pairs or cryptocurrency with more risk appetite is considered as a high-risk asset.
Importance of Risk Management
Now the main question is what is the importance of risk management. Why don't you trade without having any risk management plan? Why are risk management plans so important?
All of these questions can be answered by the traders themselves. Traders know how much benefit they get when they are trading using a risk management plan. Following are some of the major benefits of trading with risk management plans.
Avoid Big Loss
The major benefit that you will get using a risk management plan is to save yourself from any big loss. Markets like foreign exchange and cryptocurrency have a lot of risks involved. Entering such markets without any risk management plan is really a big mistake.
Save Emergency Funds
Sometimes traders enter the market with two types of funds. The first type of fund is the main investment fund, while the second fund is a secondary fund, support fund, or emergency fund.
But if you don't have the plans for risk management, then chances are there that you will lose your emergency fund along with the main fund.
Keep Things Under Control
You need to keep things under control while trading any asset. But without a risk management plan, it is not possible for all of you to keep things under control. Because as a retail trader you cannot judge what the next price fluctuation is waiting for you in the market. But a risk management plan can help you keep things under your control.
Provides Mental Satisfaction
If you enter the market with a set or fixed risk tolerance rate, then there will be mental satisfaction for you even during the loss period. You won't get over-excited or you won't overthink at the time of heavy loss, because you will know that you have fixed your risk tolerance rate.
Helps Controlling Emotions
Emotional control is a very crucial thing in trading. Whenever you are trading in markets with high risks such as the currency market or cryptocurrency market, you will find that you are out of control in terms of emotions. But now you can change the whole situation positively and control your emotions easily using a risk management plan.
Preparing & Implementation
The most important thing that you need to learn about risk management is planning or preparing and then implementing that plan successfully. If you are ready to do this then the following are some instructions for you.
Know Your Risk Tolerance Rate
You must have to fix your risk tolerance rate before initiating any trade in the market. Always keep things fixed in terms of risk.
Stick To Your Plans
Whatever risk tolerance rate you set, should be fixed till the end. Never try to fluctuate it during the trade, just because you are going to benefit. Just stick to your previously planned things.
Choosing Low-Risk Assets
As a beginner, you must try trading assets with low risk. There are different types of assets according to the risk. Some of them are associated with high risk, while some of them are traded with low risk. You must go with low-risk assets.
Include The Plan In Trading Strategy
Now the last step of your risk management plan is to include your plans in your trading strategy. What trading strategy you have prepared? Try to implement your risk management plan in the trading strategy.
Risk management is an important role player in any trading journey. No matter if you are a retail trader or you are a fund manager with a lot of funds in the bag. Risk is always the same for all of the traders.
You can never control the risk or you cannot reduce the risk. However, you can manage the risk to avoid loss. This is the only thing that traders have to learn about risk management in any trading market.
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