Every experienced and successful trader will tell you of an occasion where their theories failed to work. They will tell you of instances where after doing a lot of research, they entered into a trade only for the trade to go against them. As a new trader, you need to understand that your theories will never be hundred percent perfect. If you are really good, you will at times make good money. However, at times, you will make losses. These two instances (big profit and big loss) are the most important for any trader. This is because the human psychology will tell you to try to recover the money you have lost immediately. Also, in case you have made a good profit, it will tell you to continue with the winning streak. Quite often, this will lead you to a deeper hole than you came from. In this article, I will highlight a few ways of reducing the risks of massive losses after a big loss.
Any trader who has attended a course on trading will remember a very boring unit on psychology and emotions. Personally, I thought the unit was boring and a waste of time. Instead, I was pre-occupied with complex studies such as the Fibonacci retracement, and Ichimoku analysis. I thought my trainer was just wasting my time educating me on how to manage my own emotions. Then, when a single trade made me lose my entire investment, I now saw the sense of emotions and psychology in trading.
Risk management simply is a process of reducing the amount of money you expose yourself to per trade. Any successful trader will tell you that it is possible to make double your money in minutes depending on the amount of risk you take. They will also tell you that it is possible to lose money all your money within minutes.
One area of risk management is on capital allocation. Here, as a rule, you should always avoid making any investment with money you can’t afford to lose. For instance, you should never use your retirement funds to trade. Your retirement money should be invested in solid assets such as real estate or government backed bonds. Doing this will help you have an assured comfortable retirement.
The next area of risk management is on the amount of money that you risk at any trade. This is determined by the lot size, stop loss and the take profit of each trade. Lot size is simply the size of your trade. If you have a micro account with less than $1000, you should always avoid using more than 0.5 lot size. Here, you should not risk half of your money per trade. Unless you have millions invested, you should never use more than 5 lots.
The stop loss is the largest amount of loss you are willing to lose per trade. As explained above, you should never trade without a stop loss. A take profit gives you an opportunity to take a profit up to an area where you anticipate a reversal.
As a trader, another key risk you can put yourself through is over trading. Over trading is a process where you open more than 10 trades per day. Doing this can make you a lot of money per day. However, it exposes you to a lot of risks which you should always strive to avoid. If you trade a lot, you will be exposing yourself to a lot of losses which are uncalled for. I have made it a habit of trading a maximum of two times per day.
Accept and move on
If you have made a big loss, you should learn to accept and move on. You should also take your time to analyse the mistake you have done and try as much as possible to avoid it in future. You should also give yourself time to assess your strategy and develop a good plan in future. By so doing, you will be at a good place to avoid making these mistakes in future. You should also encourage yourself by reading about people who have lost billions of dollars trading.