“Throughout my financial career, I have continually witnessed examples of other people that I have known being ruined by a failure to respect risk. If you don’t take a hard look at risk, it will take you.” – Larry Hite
As with any business activity, risks are involved in trading as well. And if you take arbitrary risk, your current trade could be your very last one! This is because a single trade gone wrong can wipe off your entire trading account. But, you can’t really trade without risk.
Then, what should you do? You must learn to manage your risk using risk controls. Risk controls are often underestimated. However, a trader who consistently uses them can manage losses and open herself to more opportunities for successful trades.
Risk Control in trading
Risk control in trading refers to a plan-based trading strategy that focuses on identifying, evaluating, and preparing for any potential for loss. Risk represents the probability of loss when the market/ asset price moves in a direction opposite to our expectations.
For risk control in trading, one needs to keep in mind several aspects such as which financial instruments to trade in, time of entry and exit, where to set profit and loss limits, how to identify good opportunities, how to deal with markets moving against our position, how to keep emotions at bay and finally, how to stay on course with a plan.
Here are some ways to execute risk controls and their importance:
1. Plan your trade
It is common knowledge that planning can even win wars. The same concept applies to trading as well. Successful traders plan their trade before they trade.
Have a logical strategy with the stop-loss and take-profit limits chalked out. If you do not plan your trades, it is very likely that emotions will rule your trades and lead to losses.
2. Follow the one-percent rule
The one-percent rule is essentially a rule of thumb that says that you should never place over 1% of your trading capital or account in a single trade.
Thus, if you have Rs.1 lakh in your trading account, your position in any single trade should be less than Rs.10,000. This is an effective risk control strategy. However, many traders put as much as 2% too or even lower than 1%.
3. Set stop loss and take profit
As highlighted above, setting stop-loss and take-profit is an important part of your trading plan. Although it is mostly done via technical analysis, fundamental analysis also helps with timing.
One widely used indicator to set stop loss and take profit points is moving averages, given that they involve simple calculations and are also widely tracked by the market.
It makes sense to use longer-term moving averages for highly volatile stocks and also use fundamental events such as earnings, news announcements, etc. to account for the timing aspect.
Make sure you calculate your expected return. You may use the following formula: [(Probability of Gain) x (Take Profit % Gain)] + [(Probability of Loss) x (Stop-Loss % Loss)]
4. Diversify your trades
Ensure that you do not put all your eggs in the same basket. It means do not put all your capital in one trade or instrument.
Ensure you have a healthy mix of instruments to reduce your concentration risk to a particular asset class, sector, and even geography. Choosing less-correlated instruments is recommended while trading.
5. Consider hedging
Hedging is a strong risk management tool. It essentially involves taking the opposite position from your original position.
Here, if your primary position loses, the other position will still profit and make up for the loss.
What if your algorithmic trading platform itself comes with risk controls? It’s true!
PHI 1 comes with various types of Inbuilt Risk Controls that sets the trader free from the constant worry of losses. Unlike other algo trading platforms, PHI 1 not only offers standard risk control but also calendar-based risk controls.
Further, traders can create custom risk controls during strategy creation. Within calendar controls, traders can make use of day control, time control, week control, month control, and date control, which offers them the option of fine-tuning their trading strategy.
Along with superior risk control, PHI 1 offers an all-in-one trading solution so you can use your precious time exploring unique trading opportunities!
