Managing Risk - Four Mistakes Traders Make

Not everyone realizes the importance of a risk management system in trading. This is especially true for novice traders who are more concerned about the bottom line. They are mainly interested in making money. Like every other major undertaking though, this usually involves following a process.

In trading the process you would have to apply is your personal plan or system. A good plan often involves paying attention to the sizable section of controlling risks. Before you can successfully do so, you need to steer clear of common mistakes.

1. Not knowing your tolerance for risks.

Just as different people have different pain tolerance levels, individuals also have different endurance levels for risky deals. In trading it is not enough to say that you understand that there are dangers involved. A good risk management system clearly defines just how much you are willing to lose on every single trade. This concretely defined the requirement to have realistic expectations because you will know exactly just how much can go down the drain.

2. Not having a stop order.

It's one thing to know how much loss you can tolerate. It is another matter to make sure your limits stay where they are supposed to be. One way to make sure you bail out just in time from a bad position is to set stop orders. Once values drop below your predefined figure, you can take the door out.

This aspect of market risk management can also be implemented using trailing stops. Unlike static stops, this one can trail behind unit price. It only stays where it is once price starts to drop. This way, you can increase your profit potential while still enjoying protection from falling too hard.

3. Setting maximum loss too tight or too wide.

A critical part of your plan involves setting maximum loss. Traders who still have some ounce of fear in them may set this figure too low at below 1%. Others who feel that they know full well that trading is risky may set figures that are too high at 5% or more. Setting your sights too low in managing risk can limit your profit potential. On the other hand, setting it too high would mean facing the possibility of having to let go of a good portion of your capital. An ideal figure would be around 2%.

4. Using trading float for a variety of investments.

Identifying how much you are willing to set aside for trading is crucial. Obviously this is to prevent you from diverting funds for other purposes. If you plan on participating in various market types, you may consider settling for a general amount that will cover everything. If you are a novice however, it is often a good idea to focus on one market first and set your float for that one alone. This is to prevent problems from arising due to lack of market mastery.

A comprehensive risk management system is one of the most important elements to set straight. Aside from following the right steps to devising your own system, you also need to make sure you don't make the same mistakes that traders on losing streaks have made.

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