Financial markets had been increasingly volatile in 2020 and because of that, money management became even more important for retail traders. For those worried about recent volatile markets, risk can be managed even during difficult times, and the best way to do it can be summarized into 4 simple tips.
Tip #1 Analyze risk and then reward
Although large price moves can create FOMO (fear of missing out) and enthusiasm among beginners, this isn’t the right trading approach. A professional trader will first analyze risk and only then the potential reward.
In doing so, a lot of trading setups will look like “missed opportunities, but in the longer run, ignoring risky situations will result in a smoother performance, lower account drawdowns, and less emotional trading.
Keeping an objective mindset and managing to analyze the risk without any subjective interference is a real challenge, especially for traders that still have to work on their diligence and emotional regulation.
Tip #2 Risk a fixed percentage amount
One of the first instincts when market volatility increases is to also open larger positions. High volatility equals higher uncertainty and an increased probability of sharp counter-trend moves, which could result in larger losses, even though ultimately price does move in the expected direction.
Increasing risk at a time of great uncertainty is suicidal and it would be better to risk a fixed percentage amount, regardless of the market activity. More conservative traders choose to reduce risk when market volatility spikes, but it would be appropriate to at least keep risk at the same parameters all the time.
To manage risk effectively, fixed risk and consistent accuracy above 50% would be the optimal approach, regardless of the high-profits illusion beginners get when prices perform wildly.
Tip #3 Reduce market exposure around key areas
Aside from opening and closing trades, a well-prepared trader needs to know how to manage a position as the market unfolds. Thankfully, trading providers such as easyMarkets offer a broad range of tools and traders can be constantly in touch with the market performance.
During high-volatility periods, technical levels matter the most and the market tends to react impulsively around key support/resistance areas. Corrective moves will be sharper and because of that, taking at least a portion of the profits around these areas will reduce the risks associated with a counter-trend move.
Tip #4 Trade a diversified basket of assets
Because all financial markets continue to be volatile, “putting all eggs in one basket” will be a major mistake. Traders need to focus on a diversified portfolio of assets, depending on how the market changes. The list of assets to trade can change at any point, but it would be important to have a strict plan with all the trading instruments under observation.
When volatility increases, the chance of being wrong follows the same path. With diversification, a trader can balance the negative performance of an asset with proper hedging on another correlated asset.