Great trading is easy and effortless, however, getting to a point when that is the case requires hard work, states Konstantin Rabin of LearnFX.
The trading process itself should be easy, but the main work is in preparation. In order to gradually increase their trading balance, traders need an edge, a trading system that works, emotional management to flawlessly follow the system, and risk management. If any of those components are lacking, results will be unsatisfactory. What’s more, having a quality education is extremely important for success. No matter which source you use: webinars, YouTube videos, or online sources such as LearnFX, a thorough understanding of what trading is will help make proper decisions. Trading is not a job where you get a steady pay cheque. Trading is similar to running a business.
Risk management in particular sounds too elementary to most traders, however, most traders fail to effectively practice it. In a nutshell, risk management means never risking more than 1-5% of your balance per trade and avoiding low liquidity and high volatility. The more volatile the market, the harder it is to practice proper risk management. Price can easily trigger your stop loss, reverse and head in the predicted direction later, leaving you with a broken heart and an empty wallet.
Risk Management and Volatility
A rise in volatility can be caused by two factors: low liquidity and very high liquidity. Both make prices move like a roller coaster. Low liquidity means that there are few sellers and buyers, there’s a great distance between bid and ask prices, and consequently price changes sharply. It’s best to avoid trading during low liquidity, as the market becomes highly unpredictable, and you get terrible spreads. High liquidity can also cause increased volatility. Liquidity is usually a by-product of increased volume. Volume typically increases during news announcements and significant events. That’s exactly when sharp price movements are expected.
It is possible to trade during increased volatility and liquidity, however, traders need to take into account that the rules of stop loss and take profit placement change as well. To avoid getting stopped, market conditions need to be assessed properly. Typically, highly volatile markets require bigger stop loss and take profit targets than calm and steady markets.
Moreover, liquidity also changes from exchange to exchange. It’s no secret that the most liquid Forex trading hours are during London and New York trading sessions. And for stock traders, New York and NASDAQ exchanges provide the best trading opportunities. It’s best to trade during such sessions for getting the best spreads and predictable price movements.
Market Volatility in 2023
2023 is going to be a highly volatile year. 2022 has already laid the foundation for that to happen. Proper risk management is going to become even more critical throughout 2023.
The Covid-19 pandemic has disrupted manufacturing and changed the way businesses work. The pandemic was followed by the war in Ukraine and a massive increase in energy, food, and housing prices. Central banks are fighting high inflation with record-high interest rates. In 2023, we are waking up in an era of expensive money, as the high-interest rates are likely to be maintained. Major currencies such as the Great British Pound, Euro, the US Dollar, and Swiss Franc are in a highly volatile state. High volatility and increased liquidity can be a great opportunity to make more money for professional traders, however, it can also result in increased losses. When traders do not know what they are doing, great opportunities can easily turn into great losses. The key to successful market speculation is proper risk management. Increased volatility requires more attention to detail and bigger stop losses.
Some experts believe that there is going to be a recession in 2023. In a recession, economic activity and spending decreases, and unemployment increases. Usually, the main cause of recession is high inflation. Inflation forces regular people to save on goods and services to cover essential costs. As a result, many businesses lose market share and go out of business. This leads to an increase in unemployment and people find it even more difficult to afford goods and services. The economic activity drops, and the recession begins.
In case the war in Europe continues, and global food production keeps being disrupted, 2023 will remain highly risky for inexperienced traders. On the upside, there are going to be lots of great opportunities this year for speculating financial markets.
Leverage and Trade Size
Choosing a high leverage might result in losing funds altogether. Leverage is a double-edged sword, it can increase your profits and similarly become a cause for great losses. The biggest reason why novice traders lose their trading balance is that they put too much emphasis on single trades by increasing trade size. Profitable trading is based on probabilities. No matter how well you plan a trade, there’s always a chance that it might go in the opposite direction. The key to success is having a trading strategy that results in account increases after multiple trades.
Most strict financial regulators, that prioritize the safety of investors’ funds, make brokers offer clients lower than 50:1 leverage. On the other hand, there are many brokers that offer up to 500:1, 1000:1, or even up to 2000:1 leverage. It’s critical to avoid having oversized positions, as you will become susceptible to sharp price movements and the chances of blowing up the account will increase. As already mentioned, most professional traders never risk more than 1-5% of their balance per trade.
When deciding on trade size, it’s also critical to answer a simple question, whether the trade is worth opening or not. Usually, traders have one risk and more than one reward ratio in trades, however, this rule is not a must and in certain instances, there might be a 1:1 ratio and still produce profitable results. In case you are wondering how this is even possible, the answer is simple, by picking trades with a high likelihood of a positive outcome.
If a trade has a 50% chance of going in any direction, you will need one risk and more than one reward ratio for the system to increase your balance after a series of trades.
One of the main aspects of proper risk management is also how well you manage your drawdowns. As already mentioned, trading is not a job, it’s a business. And like any business, it has months when there’s money flowing in and there are months when the business requires funding from the owner. There’s no stability in trading. Returns depend on market conditions.
Drawdown periods happen for any trading system, they are inevitable. Professional traders do their best to limit the damage by decreasing the trading size or stopping live trading altogether and moving towards demo trading. Demo accounts help build back confidence and go back to regular trading later.
Drawdowns can have two causes: either the natural drawdown period has started, which is experienced by every strategy, or the market conditions have changed, in which case, the trading system needs to be upgraded.
Drawdowns are dangerous, as they can trigger traders to take revenge. Traders that are unable to receive losses, tend to ignore risk management rules. They use martingale and similar gambling-like strategies and blow up their trading accounts. Trading is far from casinos. However, for certain individuals that trade without risk management rules, it can very well become a source for gambling.
How to Increase Returns Without Increasing Risks Percentage Wise?
Managing your drawdowns professionally, with high efficiency, will help you increase your returns without increasing risks.
Professional traders that aim to become institutional traders know very well that the key to becoming wealthy is not taking huge risks and treating trading similarly to gambling. The key to success is in stability. Investors love money managers with great drawdown management skills, great risk management in place, and steady returns. Stability beats high returns when it comes to managing other people’s money.
When you have proper risk and emotional management in place, utilize a trading system that gives you an edge, and document your progress, you will be able to find investors. Moreover, you’ll be able to sell trading signals for an additional source of income.
In the world of finance, the bigger the risk the bigger the reward, however, the risk can remain limited percentage-wise and personal rewards increase by increasing funds under management. There are two major ways to increase the funds: find investors or reinvest profits and grow income by compounding.
Compounding is a tried and true method for wealth creation. While it takes time to get tangible results, the sooner you start the better. Compounding simply means reinvesting your profits. The money that was reinvested brings even greater returns. And then these returns get reinvested again, and that further increases ROI. Pension and wealth management funds use compounding methods to increase their clients’ savings. Compounding is how Warren Buffett and many other famous investors have got rich. Compounding is not possible without proper risk management, as stability is more important than returns.
By Konstantin Rabin of LearnFX