How to Lower Your Risk When Entering a Trade

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Every trade is subject to risk. Without risk there would be no reason to offer the potential for making a profit. At the same time every risk is different. In some trades the risk is very small, while others carry a huge price tag if they fail. Managing risk can be the difference between success and failure for a trader, investor or even a business owner. We can't eliminate risk entirely, but we do have some control over it and more than we may realize.

While there are many approaches to reducing risk by choosing better quality trades, our focus here will be on how to improve the risk associated with a trade you are actually taking, whatever the reason for choosing it. However, keep in mind that some trades are just plain foolish and no matter how much we reduce the risk associated with them they still remain far beyond anything we should be risking. The choice of trades is still an important matter when it comes to controlling risk. But if a trade meets the criteria you are looking for then here are a few tips for reducing the risk of that trade even further:

1. Enter when the market is closest to your stop
2. Demand that the market meet you on your terms, not the other way around
3. Beware of runaway markets

Often the criteria used for determining a trade is based on price moving higher or lower. Typical examples include using a break-out approach, an indicator crossing or some sort of momentum method. Although these are common approaches for determining a trade, there is a inherent problem with each of them. Often a trader will enter as soon as the criteria is met, which is when the market is reaching for new territory. At such a point a market will typically react severely to such an event. It will often consolidate or even retrace. In the case of a retracement, the market initially places your trade in a very negative position. Rather than holding onto a profit as you had hoped for, you are now stuck holding a loss and waiting anxiously for a better situation. Because your stop loss is so much further away than your actual entry, the potential loss is much greater as well. This makes for a very uncomfortable start to your trade.

One way to avoid this situation is to wait until the market moves closer to where you would place your stop before actually entering. Of course, we are not asking you to predict how the market will move, just to be aware of its normal range. This requires two things from you, patience and knowing the market that you are trading.

First off, always remember that patience is an essential part of any trading. Although an unnecessary delay can result in a hefty cost, rushing to commit to a trade or even to exit one can also be detrimental. Successful trading requires you to exercise a balance between the two. If you rush to judgment then the judgment will likely be flawed. Most trading entries allow a little time, even if it is very little, to choose the actual point of entry. Some offer quite a lot of time to make the commitment. Examine most charts and you will see this time and again, markets will often consolidate or pullback off of their trends before making the next move. Even if a trend shows strength and you have reason to expect it to continue without diminishing any strength, don't rush to enter. Instead, look for the market to drift a little closer to your stop and then make your move.

How far a market will move back toward your stop can be a challenging judgment call. This is where it helps to know the market that you are trading. In a very strong trend the market may only consolidate within a tight range momentarily before moving further. In tight ranges it is best to look for an entry favoring the side closest to your stop within this tight range, rather than expect a substantial pullback. This may only provide minimal risk reduction, but such a reduction can still be the difference between a profit and a loss. It also avoids missing a trade altogether.

In other cases, such as when the market repeatedly swings within a larger range, you will typically have a greater pullback that will offer an entry much closer to your stop. Look for prior lows or highs that the market is likely to have a reaction to and enter just before price actually reaches those levels. Looking at similar prior incidents in this particular market will help you determine the very best approach.

Keep in mind that the goal here is to reduce the exposure, not prevent you from ever taking the trade. So don't be unreasonable in your expectations. You are looking to improve your situation, not have it handed to you on a silver platter.

Our second tip, demanding that the market meet your terms, is about leveling the playing field. If you are always chasing a market or simply reacting to its moves then you will tend to be at the market's mercy. In case you didn't know, the market has no mercy so don't put yourself in that position. It is much better to be an opportunist than a marathon runner. Most carnivores can't outrun their prey, they set up the opportunity and then pounce on them. A tiger waiting in the bushes, a spider weaving a web, or an eagle dive-bombing on a trout, they are all opportunists. Take a lesson from their example. Don't trade simply to be in the market, look for what offers a profit opportunity and then trade that.

This advice may be easy to understand, but hard to follow. The problem is that at times the market likes to give the appearance of providing a rich opportunity for profit when a runaway move begins and we are very tempted to jump in irregardless of the fact that it doesn't match any of our criteria. There is no question that at times a market will take off in a very powerful way and all a trader has to do is get in and hold on for the ride. The problem with a runaway market is that it has high volatility and will typically swing strongly in both directions. As soon as the trend is finished then it will often swing hard against itself. To trade a runaway market you really need to be well experience, alert and nimble. It is not for the faint of heart. Even if you succeed with entering early during the trade your stop will likely still be placed at an extreme distance, making very large losses possible. If you are not up to this kind of risk then it is best to avoid it by staying away from runaway markets.

Follow these tips and it will help you to reduce your exposure in any particular trade. Although you can't control the market, you don't have to let it control you either. As with any relationship, expect it to meet you halfway. There is no reason for you to be stuck with the shaft when you could actually have part of the goldmine. Reduce your risk and more of that gold will come your way.

Article Source: http://depositarticles.com/

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