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the Online Trading Academy!

Risk, in any situation, is fundamentally rooted in uncertainty, defined as the chance of an outcome differing from what was expected. In the realm of finance, risk is specifically articulated as:

“The chance of an investment’s actual return being different than expected.”

Trading the financial markets is often described as the trading of risk. For instance, if one decides to buy EUR/USD, it effectively signifies the belief that the Euro will strengthen against the US Dollar. However, the risk in this scenario is the potential for the Euro to weaken against the US Dollar, leading to an adverse movement.

In simpler terms, financial risk boils down to the possibility of losing a portion or the entirety of the original investment.

Trading the financial markets involves accepting risk, and the willingness to “risk” the market going against us is rooted in the understanding that risk is not just a vulnerability but also an avenue for potential opportunity and significant financial gains.

In essence, Risk = Opportunity, and the relationship is direct – the higher the risk, the higher the potential opportunity.

This principle is encapsulated in the concept of the Risk/Reward Trade-Off, where the level of risk an investor undertakes is balanced against the potential returns. It can be summarized as follows:
Low Risk = Low Return
High Risk = High Return
Investors and traders assess their risk tolerance and appetite for potential returns, striking a balance that aligns with their financial goals and risk tolerance. While high-risk endeavors come with the potential for substantial gains, it’s crucial to approach them with a well-defined risk management strategy to mitigate potential losses.

Trading the financial markets involves accepting risk, and while it exposes us to the possibility of adverse market movements, it also opens the potential for significant financial gains.

In this context:

Risk = Opportunity

Moreover, the principle of the Risk/Reward Trade-Off is crucial. It states that the level of risk an investor assumes should be commensurate with the potential returns. This relationship can be summarized as follows:

Low Risk = Low Return

High Risk = High Return

The idea is that if an investor is willing to take on higher risk, they should expect the potential for greater returns to compensate for the increased risk. This trade-off is a fundamental concept in financial decision-making, guiding investors in finding the right balance between risk and potential reward to align with their financial objectives and risk tolerance. Successful traders often carefully consider this trade-off and implement risk management strategies to protect their capital while pursuing opportunities in the market.

Stop Loss Orders: The Key to Risk Management

Stop Loss Orders stand out as the single most crucial risk management tool and should always be a part of your trading strategy.

Types of Stops:

Breakeven Stops: Executed when gains equal losses, providing a level of protection for your initial investment.

Time Stops: Depend on a predetermined period passing before the order is executed. This helps to manage trades based on a set timeframe.

Trailing Stops: Set at a percentage level below the market price. This allows you to secure profits while minimizing potential losses. Trailing stops provide flexibility by adjusting to market movements.

It’s essential to embrace losses as a part of trading, manage them effectively, and learning from each experience. Neglecting losses or allowing them to accumulate unchecked can lead to significant setbacks, potentially wiping out your entire trading account. Therefore, disciplined risk management, including the use of Stop Loss Orders, is crucial for long-term success in trading.

Understanding the relationship between risk and return is fundamental in investment and trading:

Low-risk investments typically offer lower return potential.

Medium-risk investments come with a moderate return potential.

High-risk investments offer the potential for higher returns.

Your trading style often determines the level of risk in your strategy. Even the most effective strategies are limited if risk is not properly managed.

Your Risk Tolerance plays a crucial role, representing your ability to handle uncertainty about potential losses in your investment portfolio. Your risk tolerance is influenced by:

Income: Personal income and circumstances affect risk appetite. For example, someone on a low salary about to get married might have a lower to moderate risk appetite compared to a single person on a median salary.

Time Horizon: The duration you plan to keep your money invested. Longer time horizons are associated with less risk compared to shorter time horizons.

Investment Objectives: The magnitude of your financial goals influences the level of risk you are likely willing to take on.
Ultimately, your risk tolerance is unique to you, and a thoughtful consideration of income, time horizon, and investment objectives will guide you in determining an appropriate level of risk in your investment or trading strategy.

Asset Allocation: Balancing Risk and Reward

Asset allocation is an investment strategy designed to balance risk and reward by distributing a portfolio’s assets according to your investment goals, risk tolerance, and time horizon.

Different asset allocations carry varying levels of risk. Here’s an example of the risk associated with different allocations:

• Aggressive Growth: High Risk
• Growth: Moderate to High Risk
• Balanced: Moderate Risk
• Conservative: Low to Moderate Risk
• Income: Low Risk 

Diversification: Reducing Risk through Mixing

Diversification, a risk management technique, involves spreading your portfolio across various investments. It helps offset unsystematic risk, which is specific to industries or companies. The rationale is that poor-performing assets may be balanced by better-performing ones, smoothing out unsystematic risk.

Correlation and Diversification:

Gold and the US Dollar: Inversely correlated; gold appreciates as the dollar weakens.

Gold and Crude Oil: Correlated; rising crude oil prices often lead to an increase in the value of gold as a hedge against inflation.

Controlling Leverage: Reducing Risk

Leverage, a tool to magnify profits, should be tailored to your risk appetite. Adjusting margin requirements can reduce leverage for those who are risk-averse.

Be Cautious with Leverage:

Leverage can be compared to a credit card; use it wisely and avoid getting carried away with borrowed money.

Technical Analysis: Enhancing Risk Management

Technical analysis is a vital tool in risk management. It helps:

• Identify entry/exit points.
• Recognize support/resistance levels.
• Strategically set stop-loss orders.
• Identify trends and chart patterns.
• Establish risk parameters using technical indicators.

Utilizing technical analysis aids in risk reduction and improves the likelihood of profitable trading.

1: Use Stop Losses

Using a stop loss – a present level at which an open trade is automatically closed – is standard good practice as this can limit your downside risk and also shows trading discipline which is paramount in developing a healthy trading account. However, when markets are incredibly volatile you could experience some slippage with the position not being able to be executed at the exact level specified. In volatile markets, there is often a “gap”, where a product moves substantially lower or higher than expected perhaps as much as 10-15%. With a normal stop loss, you will get the first available price which could cause a large loss and result in a loss greater than your initial deposit.

2: Reduce Your Trade Size

Margin is one of the biggest advantages of CFD trading and at Accuindex Markets our 0.25% on FX, 0.50% on spot gold and major Indices and 3% on commodities are among the most competitive in the marketplace however with any margin trading you should always be aware of how much is required to keep your position in the market A general rule of thumb is that no single trading position should amount to risk exposure of more than 5% of your available capital. However, in volatile market conditions, this kind of leverage is dangerous as any loses will magnify by even more than normal. The best market practice would be to halve your normal trading size over volatile trading conditions.

3: Limit Your Trades

Volatile markets are associated with high volumes of trading, which may cause delays in execution. While online trading normally means you place a trade at a current bid and offer you see, some market maker may widen bid-offer spreads or even temporarily withdraw tradable prices. This means that execution can be delayed and prices to execute it may not be available. Accuindex provides fixed spreads no matter what market conditions but in times of increased volatility it is sometimes better to limit trade execution.

4: Stick to Your Strategy

During volatile times, it’s easy to be shaken and diverted from your normal trading strategy but most experienced traders apply the same strategy to choosing investments as they normally do. While it’s tempting to react to the volatility, it’s incredibly difficult to predict moves in the short term, so you have to stick to your trading strategies and limit your risk exposure when times are volatile.

What are the important bits?

• We need Risk Management to control our losses
• Always be sure to know your Risk Tolerance
• Have a Risk Management strategy – Leverage/Volatility/Diversification/Asset Allocation
• Incorporate a Stop Loss strategy as part of your Risk management strategy.

Be disciplined in affecting your strategy.

PLAN YOUR WORK AND WORK YOUR PLAN