We all know that the fear of losing money can make you hesitate or even prevent you from taking up potentially profitable investments. The trick is to understand where the hazards lie and know what you can do to avoid them. Here are five principles to help reduce your risk.
Learn and Practice Sound Principles?
It’s obvious that it’s risky to put all your money on one trade – but do you realize how little you should risk losing on each trade if you are investing for the long term? Many experts put it at 2% or less of your account.
You can learn how to calculate the possible drawdown on your account so that you don’t get any nasty surprises. The practice of position sizing will tell you just how much you can afford to invest in any particular stock.
Use the Right Strategy?
Before you even get to the finer points of stock selection, you need to make sure that you are looking at the right kind of strategy for the current market conditions. Taking a bullish stand in a bearish market is unlikely to work.
Your trading education should include learning about the way the markets work and how you can determine what they will probably do next, using technical analysis.
Test Your Tactics
Knowledgeable investors don’t have to rely on their instincts or someone else’s advice. They know how to test the strategies they want to use and make a point of doing that before risking any money.
The goal of your investment strategy should be to make a reasonable or better return in the long term. You can back-test on past data, which gives you a view of how much you’re likely to make in the future.
Know Which Orders To Use
When you make a trade, you can just accept the price that your broker gives to you. With the right strategy, you should still make a profit.
There are many other ways of giving an order to your broker, and some of them will save or make you money over simple market orders. In fact, sometimes you won’t even enter the trade unless the price is right. Your investment education should include knowing when to use the different orders.
Write It Down & Stock To It
However well your trading strategy tested, it is natural to second-guess it if you have a run of bad luck, resulting in a series of losses. Almost inevitably, once you start trading on impulse you can easily lose control, and have no way of even tracking what went wrong.
You can reduce your risk by writing down your trading strategy, clearly and unambiguously. It should be detailed enough that someone else can pick it up and use it. Once you have it in black and white, you still have to stick with it to make it work, but it is much easier when it is written down.