Risk Management: Protecting Your Account Balance and Your Emotions

The markets go up and down, and so will your account balance if you are not careful. Winning traders manage risk. There are many ways to manage risk. Some traders patiently wait for high probability setups, while other traders limit the amount of money they risk on any given trade. What strategies do you use to manage risk? How do you compare with other traders?

A group of traders were asked to take the following true-false quiz. If the item was true, they were to give themselves a score of 1. If they thought it was false, they would give themselves a score of 0.

You can take the same test. Answer true or false for each of the following items, and see what score you get:

1.  I stick to my stop loss rules regardless of how I feel when the price approaches my stop-loss point.

2.  I never risk more than a small portion of my trading capital on any given trade.

3.  Before I make a trade, I always determine my risk limit and my profit strategy, taking into account my capital.

4.  I keep records of my past trades and carefully analyze them from time to time.

5.  I always develop stop-loss rules before executing a trade.

What score did you get? If you received a score of 0, 1 or 2, you scored in the lower quartile, which means that less than 25% of the traders who took this quiz obtained a score as low as yours.

In an analysis of the testing, it was discovered that individuals who scored in this range were stressed out while trading. They experienced unpleasant emotions, lacked discipline, and had low self-esteem.

In contrast, if your score was 5, you scored in the upper quartile, which means that 75% of the traders who took this test obtained a lower score than yours. We found that individuals who scored in this range tended to approach trading in a carefree manner, showed self-control, and preferred a logical well-planned approach to trading.

How well do you manage risk? Managing risk not only protects your account balance, but it also helps you control your emotions. In this study of traders, it was discovered that traders who managed risk were less stressed out and tended to experience positive emotions. These findings suggest that you will feel calmer if you minimize risk. If you are not doing so now, it's easy to start taking some basic precautions. For example, develop a well-formulated trading plan before you execute a trade. Determine how much risk you are taking up front, and decide if you want to actually take that risk. When used properly, by accounting for price fluctuation, protective stops are another effective way to minimize risk. Risking only a small portion of your account on a single trade is also useful. If you truly feel that risk is at a minimum and bearable, you will feel safe and relaxed. And when you feel relaxed, you will be able to trade more freely, creatively, and profitably.

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