Social Trading and Risk Management
This lesson will cover the following?
- What is risk management?
- The importance of risk management in social trading
- Final words
Risk management in social Forex trading is another important factor that will contribute to your overall profits. In many cases money and risk management are the two sides of the same coin, which means that they are both equally important if you want to be successful. However, where money management tells you how much you can invest, risk management tells you if you should do it at all. Risk management will help you gain an overall concept of when it a good idea to enter a trade, as well as if its a good idea to follow a certain trader or not.
What is Risk Management?
Just like money management, the definition is contained in the name. Risk management is a set of rules you devise that help you determine whether or not a situation is too risky or not. If you have good risk management habits, you will never enter trades with a high risk factor, which means that you will further cut your losses. Good risk management is the heart of responsible trading.
However, risk management doesnt necessarily require you to never take chances. It does require you to know when a trade is too risky for your style or your strategy, though. Even if youre the high-risk, high-reward type of trader, there are some trades you should enter because they might not fit your style, or simply because the chances of winning are too small and even if you do win, the profit is not worth the risk. At the end of the day, this is what risk management is all about – finding out if the potential profit is worth the risk. Some traders lose a big percentage of their trades, but the ones they win are enough to compensate for the losses. That being said, in order to pull something like this off, you need to be really experienced. Make sure you dont trade recklessly and that the risks you take are worth it.
Risk management is a process. First you need to evaluate the risk and then you have to decide what stance to take. Will you take action or not? Is the potential profit worth the risk? Those are the kinds of questions you will have to constantly ask yourself. Bad risk management can easily lead to your financial ruin. Good risk management can help you stay in the game for a long time.
The Importance of Risk Management in Social Trading
There is no way to stress this enough – whether you like big risks or not, risk management is crucial. Risk management helps you evaluate the trades youre undertaking in relation to the potential profit. No matter what your strategy is, you should always know the risk.
Unlike money management, risk management is much harder to define because its much more subjective. What one trader might deem risky, another one find adequate, and even favorable. For example, some copy traders dont think that investing more than 50% of their entire portfolio at one time (but in different traders) is risky. In our opinion, though, this can lead to significant losses while the potential for profit is not that great which means that its not worth the risk. There is nothing wrong with investing in five traders at the same, or even more, but we think that 50% of your portfolio is too much. Some traders might argue that this is not the case, which is why we said that the whole problem is rather subjective.
Still, you need to always carefully weigh out the risks before you take action. This is how good risk management works. Sometimes the risks are low – there are trends that clearly show the direction of the price movement so its almost safe to assume that the prediction were making is correct. However, there are times when its rather unclear whats going to happen. We need to be aware of those times and simply stay put without taking action. Dont invest money just because youre bored or because you want to see what will happen (if thats the case, you can use your demo account).
There are a few things you can do in order to mitigate risks. The first thing is diversify your portfolio. Dont invest too much in the same thing. Try different trades, study different fields. This way you are improving your chances of success. At the end of the day, though, nothing in trading is certain. This means that whatever you do, you will have to take risks. Trading is not everyone. You need to be able to quickly evaluate situations and take risks. If youre too scared of failing, you cant be a trader. Everyone fails at one time or another. The important part is to keep profits over the losses.
Proper money and risk management are essential for anyone who calls himself a serious trader. The way to success goes through discipline. If youre not disciplined, then you will probably fail. However, if you manage to develop good habits, youre one step closer to becoming an extraordinary investor.