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
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.
Plan your risk management strategy.
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. 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
It may be a good idea to establish a maximum amount of money that your are 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 $3 USD on any given trade, out of a 100 USD account.
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 a pip.
Assuming that for a specific asset the pip value is equal to $1 USD, and the acceptable risk is $3 USD, then a trader may consider placing a stop-loss with a value of 3/1 = 3 pips from the level where the transaction was opened.
Make use of all the different orders available on the MetaTrader 5 platform
Stop-loss orders are additional orders available for both pending orders and market orders. They can also be attached to already opened positions on a given market. These types of orders are the most basic orders designated for limiting the potential losses, for example when an investor is not able to follow prices all the time.
A trader establishes stop-loss levels by either specifying the level in points from the current price or by specifying an exact price level. For long positions, the stop-loss value must be lower than the current price.
For short positions, the stop-loss value must be higher than the current price.
Take profit is an additional order available for both pending orders and market orders. They can also be attached to already opened positions on a given market. The difference between this order and the stop-loss order is that in the take-profit order, a trader will fix the exact profit he wants to realise.
Sometimes, investors are not actually sure how much a price will continue its direction, so they fix a value for which a profit is guaranteed if the price reaches that level. For long positions, the take-profit level must be above the current price.
For short positions, the take-profit level must be lower than the current price.
Please obtain independent advice from an independent financial advisor if you have any doubts as to the instruments’ specifications and the market’s mechanisms.