Understanding Risk Management, and Calculating It When Trading Online

February 24, 2022

For some reason, risks when trading online is a topic less discussed. Sadly, the majority of traders would rather ignore this important subject, turning to wishful thoughts instead of looking reality straight in the eye.

However, risk is a central factor that shouldn’t be overlooked or underestimated. In forex, or any other form of online trading, analysis and management of possible losses are among the underlying pillars of success. 

What is Risk Management? 

In simplified terms, risk management is a method through which probabilities of losing are identified, measured, and analyzed before making a decision. It may happen consciously or subconsciously. Using the pip value calculator, for example, is a technical method of gaining clarity of the risk. But there is a whole lot more to risk management than just that.

Each trader has their own level of tolerance toward threats of losses, as opposed to possibilities of gains. Therefore, anyone involved in online trading should learn the value of risk management according to their own goals and needs.

How to calculate risk?

Risk management may seem complex when you are doing it for the first time. To calculate and manage prospects of losing, traders can use the risk/reward ratio that compares the expected returns against the threat involved. Its calculation is simple – you divide the amount a trader will lose if the price moves against their trade by the expected profit when the trading position closes. 

How to reduce risk

Ideal risk management strategies should target the reduction of losses. So, how can you reduce or manage the threats of losing money? Well, there is no clear answer to this question. However, varied strategies can be used to mitigate the dangers of losing money when trading online. 

Stop Loss 

Stop Loss is an advanced market order that disallows continuous losses in a single trade. It sets a limit to potential losses. Using it, traders set a target in advance that they want to achieve. They set the amount of money that they are willing to lose if they start losing. It prevents excessive losses.

It is a good risk management tool for traders with multiple ongoing deals who are unable to keep track of all their active trades. 

Portfolio diversification 

Portfolio diversification is a quick way of reducing and managing risks when trading online. It involves spreading the probability of losing in various contracts for difference (CFD) instruments. This simple decision allows you to avoid losing all your money in case one financial instrument disappoints you. 

Watching the size of your capital

The size of your capital determines the degree of threat of losing money. It is a subjective factor because different people have different financial capabilities. At an individual level, you should trade an amount that you are comfortable losing. If you are an amateur trader, you should start small to avoid big losses at once. 

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