Risk Management Tools

Risk management and money management are two things every trader should have as part of their trading plan

. While they can be similar, it is important not to confuse risk management with money management. When incorporating risk management into a trading program, there are four tools every trader should use.

Many traders do not understand the difference between risk management and money management. Often, traders mistakenly think that the risk management principles they have incorporated into their trading will suffice as money management as well. Risk management and money management are two different aspects of trading that all traders should make part of their daily trading strategy, but they are not the same. Risk management addresses the amountof risk a trader will accept on a given trade. Money management is the strategy for increasing and decreasing your position as your account moves up and down.

The goal of risk management is to accept and limit risk. There are four main risk management tools that every trader should use. Mastering these simple tools will help you more effectively incorporate your risk management strategies into your trading.

The first risk management tool is to use stop losses. A stop loss can be an amount you set in a variety of ways, such as just picking a dollar amount. If you should ever meet the amount set in your stop loss, that would be a signal to close your positions and evaluate your trading. A stop loss allows you to exit a trade before you incur a large loss, and it will also help you prevent unnecessary risk by limiting the risk often found when a market goes against the direction that you anticipated.Another risk management tool is to set profit targets. A profit target will help you know when to get out of a trade in order to make a profit. What is the risk of being in a profitable trade? It is always a possibility that a trade could go against you, and your winning position could turn into a losing position before you have the opportunity to lock in profit. Profit

targets can be set and incorporated into your trading so you know when to get out for a profit, and avoid the risk of a loss.

A third tool for risk management in trading is setting a time stop. A time stop will help you see when the conditions are no longer ideal so that you can exit the market. It will tell you when your entry conditions are no longer present, or the market or markets that you are trading are not conducive to trends or the type of movement that you expect from your trading strategy.

The final risk management tool every trader should have is position sizing. With position sizing, traders can select positions with risk management in mind in order to limit their market exposure and risk on a given trade. It is important to understand that there is no such thing as a risk free

trade or investment. In fact, even the conservative investments, such as CDs, have risk involved. In these types of trades there is still opportunity risk. By putting money in an investment that guarantees a specific rate of return, there is always the chance that you are missing the opportunity to make more money with another investment. Keep this in mind

when you are creating a trading plan, and also when you incorporate money management into your trading.

Using these tools cannot eliminate all risk from trading, but it can help to decrease the risk involved in trading. When you combine risk management with money management you will spend less time worrying about the potential risks of trading and be able to focus on your goals and trading plan.

http://www.rockwelltrading.com/Blog

by: Markus Heitkoetter, Rockwell Trading

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