As Gary Cohn once said, “If you don’t invest in risk management, it doesn’t matter what business you’re in, it’s a risky business.”
Effective risk management is the only lifeline of both trading companies and individual traders alike. It is hard to imagine that anyone would be under the illusion that in the fast-paced competitive world of trading, they would be able to make any success without properly managing risks.
So how can we do it, and what strategies can be followed to help hedge your trades?
In a nutshell, the entire objective of risk management is to identify, assess, and mitigate potential risks. It all starts with analyzing the potential impact of market fluctuations and potential economic changes while keeping a close eye on those pesky external factors that can all too easily start affecting the outcome of trading accounts. Whether you are a lowly retail trader sitting in a dingy office and playing with penny stocks or a hedge fund manager betting big with billions on the line, only by identifying and assessing the potential risks will you be able to take proactive measures that can help to mitigate or avoid them.
Once you have spotted the possible shortcomings there are a few simple methods to put your mitigation tactics into practice. Diversifying your portfolio or using hedging against market fluctuations are two of the keys to proper risk management.
Let’s take for example hedging in the FX market. As described through these hedging strategies that help eliminate risks by axiory.com, direct Forex hedging, Forex correlation hedging, or Forex options hedging, can all be employed with different levels of success depending on the market. While not all FX traders use these strategies to help offset their potential short-term losses, risk management also plays a critical role in ensuring the long-term stability of a trading business. The FX market alone sees over $6.6 trillion in daily trading volume, with a vast amount not being hedged in any meaningful way.
Only by effectively managing risk, trading companies as well as individuals can protect their capital and avoid the financial losses that result from form unexpected market changes that can so often spell ruin for those involved in the investment world.
Where to start?
Effective risk management starts when a person decides to take charge of their finances and take a hold of their trading. What this means is that not only should you always plan your trades and trade your plans as the old adage goes, but you need to be certain of a few things:
- That the stop-loss orders you put in place are effective
- Choosing a proper position size is not something to be taken lightly
- Make sure that you are using a hedging strategy that works with your trading style
- A diversified portfolio is a safe portfolio
- Always be ready to adapt to the market
While all these things are crucial to making a success in trading, overlooking just one can spell doom and see a trading account go boom.
It hardly matters if it is a giant trading firm taking a position in the market or a retail trader just playing around, traders should always have a plan for entering the market and exiting trades with a realistic outlook.
Adapt or die
Most of us know the saying “adapt or die” well enough, but one key aspect of risk management is regularly monitoring and reviewing the effectiveness of the trading strategies that are being used. Things change, and in the markets, things change a lot and fast. Trading companies and individual traders can only make money if they are willing to make the necessary adjustments in order to stay ahead of the potential risks while attempting to maintain their edge in the market.
It is easy to think that because everything is hunky-dory today, it might not be as necessary to take the same precautions as we did yesterday; but this fallacy will leave you with empty pockets and wishing you had implemented proper risk management. If we were to look at the average stock market return in the U.S. for 2017 to 2021, we would be seeing a steady 10% return annually. But like we saw in 2022, all this data can be turned upside down in just a few months, proving once more how important it is to make sure that you prepare for all eventualities.
Effective risk management is essential for the success of both trading companies and individual traders alike. Anyone wanting to enter the market and emerge victorious over the ebbs and flows of the financial world needs to continually identify and assess the potential risks, and take proactive measures to mitigate and avoid them. Neither trading companies nor individual traders can protect their capital successfully or hope to increase their wealth without making sure that they implement effective risk management.