Managing risk while trading
Knowing when to get out of a trade is as important as knowing when to get in. In an earlier article, we discussed the various parts required to define your strategy. We looked at how you can decide when to enter into a trade. We now look at best practices traders need to adapt so that they can not only maximize their profits but also manage their risks well.
When to exit?
Every battle is won before it is fought — Sun Tzu
Trading requires you to plan out rules that help you define when to enter and exit. While building your strategy, you always start off with a hypothesis about ‘why’ you think you entered a trade. Only having a hypothesis is not enough. The hypothesis needs to be validated and protections need to be added to make sure that we can make the best out of the trade.
Deciding when to exit depends primarily on the hypothesis you are starting with. For example, if your hypothesis is based on short-term market trends then you might want to exit as soon as the market trend reverses.
Stop-Loss(S/L) and Take-Profit(T/P)
Take-Profit helps you maximize the potential upside of a trade while stop-loss helps to prevent large losses. Take-profit is a point where a trader feels additional upside is limited given the risks. Eg: If the price approaching a key resistance level after a large move upward, traders may want to sell before a period of consolidation takes place. Take-profit prevents traders from falling in the “this will go up” trap
On the other hand, a stop-loss point is a price at which a trader will sell and take a loss so as to limit the max loss that can happen on the trade. This often happens when a trade does not pan out the way a trader hoped. The points are designed to prevent the “it will come back” mentality and limit losses before they escalate.
Setting up effective Stop-Loss and Take-Profit
Best way to set up an S/L and T/P is with technical analysis. There are different methods that you can use for the same
Trailing S/L and T/P: The simplest way to apply a stop-loss/take-profit is to ‘trail’ the market movement and then place an order once the price has moved below a threshold. This is the simplest method trades use to prevent losses.
You can read more about them here:
Support and resistance: A support level is a level where the price tends to find support as it falls. This means that the price is more likely to “bounce” off this level rather than break through it. However, once the price has breached this level, by an amount exceeding some noise, it is likely to continue falling until meeting another support level.
A resistance level is the opposite of a support level. It is where the price tends to find resistance as it rises. Again, this means that the price is more likely to “bounce” off this level rather than break through it. However, once the price has breached this level, by an amount exceeding some noise, it is likely to continue rising until meeting another resistance level.
Traders use technical analysis tools like ‘pivot-points’ and ‘trendlines’ to identify key support and resistance levels while they do the trade. These are the most popular ways of setting an S/L and T/P.
Moving Averages: Moving averages help traders identify trends and are popular because they are easy to calculate and widely tracked by the market. Key moving averages include the 5-, 9-, 20-, 50-, 100- and 200-period averages. Traders typically try and close trades when the price line crosses above/below the moving average line.
At Mudrex, we believe in providing traders with the best tools to trade so that you can focus on making and optimizing strategies quickly. With over 150 indicators and 8 different settings for stop-loss and take-profit, Mudrex provides you with a comprehensive complete risk management framework to help you trade better. Come! Build your strategies with us! Signup now
Links
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Originally published at blog.mudrex.com on January 2, 2019.
