What is Risk Management and How do You Implement it?

One of the most important parts of your strategy as an entrepreneur trader is your risk management. Entrepreneurs know all about risk. But many novice traders will initially focus on the impetus to enter a trade but will fail to focus on when to exit a trade. Similar to knowing when to sell your startup. Before you initiate any risk, you should go through several steps to determine the risk you will assume, and the potential reward that is associated with that risk. Your risk management should cover your long-term investment approach, each trading strategy as well as each trade you decide to execute on online trading.

Different Levels of Risk Management

Risk management is the process of determining how much capital you are willing to risk. The process starts with the amount of capital you are willing to invest in any asset. This could be on a house, for your college savings, your retirement, or for your discretionary trading. This part of risk management is referred to as asset allocation.

Asset Allocation and Diversification

Part of allocating assets to diversify your portfolio. When you diversify you are avoiding putting all of your eggs in one basket. If you don’t diversify, you run the risk of an adverse scenario occurring wiping out your savings. You can diversify by owning multiple assets, as well as trading multiple strategies. This could be a combination of a buy and hold stock strategy as well as a day trading forex strategy. By diversifying your trading, you are creating a risk management strategy that has multiple fail-safe provisions.

Strategy Risk Management

When you diversify your portfolio you should consider placing a maximum loss on any strategy. While this concept is more important when you trade the markets on a short-term basis, this can also include a buy and hold strategy. For example, there are many buy and hold strategies that tell you to add small portions of capital to your holding each month especially when you are young. This has historically worked well, but if you feel you are headed into a recession or even depression you need to think wisely about adding to a losing position.

If you develop short-term trading strategies, before you begin to risk your capital, you should determine how much you are willing to lose on the strategy. For example, if you allocate $10,000 to a strategy you might consider pulling the plug if the strategy is down by more than 20%.

Risk Management Per Trade

Each trade that you make when you execute a strategy should have a stop loss level where you admit that you are wrong. You never want to trade a strategy that can provide a risk of ruin where you could lose all your capital at once. The best way to manage your risk on each trade is to use a stop loss. This is a level where you will admit that the trade is not going to make money and you exit with a loss. The stop loss you place can be a percent loss, a dollar loss figure, or even based on a price level. Your profit calculation can be based on the amount that you are willing to lose on each trade. For example, you might consider attempting to win $2 for every dollar that you risk on a trading strategy.

The Bottom Line

The upshot is that risk management is a key component of any trading strategy. At the highest levels, you need to allocation your capital correctly and diversify your assets, especially if you have a lot invested in your startup. You need to have a maximum that you will lose in any strategy that you envoke. Lastly, you want to make sure that each trade has a stop loss and take profit level to make sure that you avoid the risk of ruin.