These two concepts are closely related to money. Capital management defines the rules of profit distribution, while risk management defines the ways of preserving the capital on deposit. By following simple recommendations, you can steadily preserve and increase your capital.
Investments in securities always involve a degree of risk, whether in options, fixed income securities or currencies. The risk associated with each asset class depends on the characteristics of the investment itself and the impact of related factors. Fixed income securities, for example, are generally considered a very safe asset class (depending on the credit quality of the bond) and typically provide investors with a fixed amount of income over the life of the bond or at maturity. Foreign exchange, on the other hand, is considered riskier due to its volatility and unpredictability. All asset classes carry some degree of risk, and stocks are no exception. While it is important for traders to speculate on the direction of a stock, the end result is never certain, and traders have no control over which direction the stock will move after the trade is completed. So their money is at the mercy of the market.
Let’s start with safety. Risk management implies calculating the size of a deal taking into account possible losses. For example, if you have a deposit of $1000, and the acceptable risk for one transaction is 1%, or $10, then the stop-loss level should be 15 points from the price, i.e. one point should cost $0.67. This corresponds to a volume of 0.06 lots.
This value will be specified in the terminal dialog box in the “volume” field when opening a position. Beginners may object: “But the profit will be less”. However, experts know for sure that greed has never done anyone any good!
Money management involves different strategies for profit distribution. You should decide for yourself whether you want to “build up” your deposit as quickly as possible in order to steadily profit from much larger trades than those currently allowed by risk management, or whether you are focused on long-term work with the existing volumes of trades, making sufficient profit for yourself and incurring imperceptible losses.
Whichever strategy you choose; it will take into account the following parameters when distributing profits:
Deposit growth (the percentage of profit you leave on deposit to increase trading volume);
NP (non-negotiable reserve, or capitalization – a percentage of profit that is placed in a separate account and used to compensate for deposit drawdowns in order to maintain the planned trading volume in the next trading period);
Salary (the percentage of profit that you withdraw from your account and spend on yourself, family, friends, etc.).
It is easy to see that with the following allocation parameters:
Deposit Growth = 60%
NP = 20%
Salary = 20%
The goal is to ramp up the deposit and eventually earn a better profit with each trade. With the following parameters:
Deposit growth = 30%
NP = 40%
Salary = 20%
You can create a “safety cushion” more quickly, which will allow you to soften the requirements of risk management.
Dear friends, trading psychology, as a branch of knowledge in this field, studies and influences the inner state of the trader and seeks to bring him to the appropriate calmness, turning into confidence in his actions. As experts in the field of trading, we are ready to share all our experience and knowledge with you in group or individual trainings. Our experienced eye will quickly identify the shortest path to your personal professionalism!
SummeryRisk and money management may not be as exciting as stock speculation and deal making, but they are what determine a trader’s long-term returns. If you follow the “golden rule” and risk only 2% per trade, the likelihood that successive losses will wipe out your trading account remains very small. Other ways to reduce the probability of losses are to diversify trades and reduce the correlation of open positions.