Risk management comes naturally to some people, even if they are trading with play money. trader
The top traders have a knack for knowing when to take risks and when not to, but many never bother trying to understand what risk management means.
They don’t bother learning how it works or why it is essential. If you want an edge in the markets, you must learn about risk management or suffer the consequences of your naiveté.
Risk management is something that every trader does, whether consciously or subconsciously.
However, there are ways to make yourself better at managing risk by studying this market phenomenon more carefully and treating your practice sessions as scientific experiments designed to improve your knowledge base towards becoming a master of risk management.
Risk management strategies
Applying risk management strategies will help you grow your account balance while also maintaining a winning percentage over a long period.
Risk management can turn an average trader into a great trader with properly applied knowledge of how the market works. It is much more critical for you to manage your trades well than it is for you to pick winners all the time.
It might seem counterintuitive, but if you are managing risk poorly, then even if you are correct in predicting price direction 50% of the time, your account could still end up being entirely obliterated by sheer volatility and risk exposure.
The only way that anyone can become successful at this game is by mastering both sides of the equation: knowing when the price will move where they expect it to go and manage their risk appropriately.
Looking at volatility
The first step is to define the different types of volatility that prices might undergo during any given trading session.
Volatility can occur for many reasons; some are good, and some are bad, but they all affect how you should choose to manage your trades.
Explosivevolatility occurs when there is a significant movement in either direction after an extended period of relative calm without much price action at all.
These explosive moves often quickly revert towards equilibrium after reaching their apexes, making them great opportunities for profit-taking traders looking to bet on the retracement itself.
An example of this type of volatility would be last week’s price action on the GBP/JPY, as it rocketed up after a period of consolidation and then reverted to its original range. This type of volatility is typically referred to as usual or regular because it happens so often.
However, you still need to understand precisely why it is occurring and how you use this information to your advantage during the trading session.
When explosive volatility occurs near critical levels, such as strong resistance and support, traders often refer to it as an “explosive breakout”.
These sorts of breakouts can be misleading because they look like trades you should take advantage of but sometimes move too quickly for your risk parameters.
The best way to properly manage your entry points when volatility starts increasing is by combining several indicators, such as volume analysis and candlestick formations.
These things will give you a better idea of where the price will be tomorrow instead of assuming that it will continue in the same direction for an extended period.
It brings us to the second type of volatility: earthquake volatility. This sort of movement can occur after trading has been relatively calm, but the market makes a surprise move against all expectations.
An example would be if price jumped five pips on low volume when everyone expected it to pull back before continuing with its bullish trend.
Earthquakes are not sustainable because there is no real pressure behind them. They are usually just temporary deviations from equilibrium price levels before returning to their everyday trajectory moments later.
This volatility is the hardest to trade because many traders have no idea why it occurred in the first place, and it can often be a sign of a significant turning point in a currency pair that could signal either a trend continuation or reversal.
You need to look at why this type of price movement occurred and whether or not there was any fundamental data behind it.
Suppose you see an earthquake breakout on low volume with nothing fundamental to back up the move.
In that case, you know that this is simply average volatility appearing out of nowhere due to some market manipulation.
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