Humans are more prone to avoid pain than to seek pleasure. However, this concept goes out the window for traders who are looking for an easy way to make money. They tend to focus on the rewards, without carefully considering that all rewards involve some risk. In order to increase your rewards as a trader, you have to seriously consider the risk.
Understanding your risk-reward ratio is called money managing. When developing your money management skills, focus on the risk before the rewards. This is also helpful when looking for a tool that will help you calculate your risk-reward ratio. Why should a trader pay more attention to the risk?
1. Losing is inevitable.
Traders often under prepare for losing trades or fail to understand that their account can go through a string of losses. They may calculate for a few losses, but they don’t always determine just how badly they can end up losing. When you focus on the risk rather than reward, you are more likely to prepare for the inevitable loss that your account will suffer. Traders that carefully consider the risk involved with each trade make better trades and are more consistently profitable.
2. Test samples need to be larger.
One of the biggest misconceptions in trading is that a test sample of 100 trades is enough to determine if you will be profitable. However, profitable traders know that in order to truly money manage, and become profitable with Forex, a trader needs a test sample of 10,000 or more trades. The right software is required to do this, and traders who look for this type of software think risk first. Their mentality isn’t simply ‘which tool will help me get amble profits’ but ‘which tools will help me avoid losses.’ This type of trading mentality requires shifting from reward driven trading to ‘lose prevention’ trading. Because the more you risk manage, the more likely you are to be consistently profitable.
3. Less prone to scams.
Forex scams are everywhere. A trader needs to be alert if he is to avoid them. Traders who think risk first are less likely to fall for scams. They don’t fall for the hype that Forex is an easy way to make money, or that anyone can do it. When you think risk first, you carefully analyze the information you’re getting and whether or not there is validity to it. You also consider yourself (your personality, your lifestyle, your strengths and weaknesses) as a trader and whether or not trading is actually for you. When you take the time to reflect on the risk of being a trader, you are less likely to fall for a Forex scam.
4. Less emotional trading.
Trading is a very emotional act. The fear of losing, the greed that can come with multiple wins, all help to make a trader an emotional wreck. Emotional trading will cause a trader to make avoidable mistakes. A number of emotional traders do not have proper money manage. They focus more on the gains and when they see themselves losing they become anxious etc. But a trader who thinks risk first is less emotional. Why? They are prepared. Money management also helps traders to emotionally manage themselves. When you are emotionally prepared for losses, you don’t get the panic attacks and anxiety that some traders experience. Because you have taken the time to carefully calculate the risk, and know exactly what you can handle, you’re less likely to make common trader mistakes such as moving your stop loss or pulling out of a trade too soon.You may feel excited about the rewards you gain as a trader but in order to obtain those rewards you have to consider the risks. Thinking risk before reward can help you become a better trader who makes consistent profits.
There are few things that can make a grown man as worked up and emotional as trading. Gaining money gives the trader a rush, a boost of confidence, and a feeling of achievement. Loss on the other hand can make the trader experience self-doubt, anxiety, and in some cases depression. Traders who are consistently profitable are able to control their emotions. Being able to effectively emotional manage is a skill that needs to be developed, but he must think risk first.
A trader cannot be consistently profitable without good money managing skills. Most ‘gurus’ will simply tell you to look at your risk to reward ratio when money managing. But what’s interesting is that majority of traders will consider their rewards more than the risk they have to take. What they don’t grasp is that trading is not just about winning. Losing is a huge part of trading; it’s inevitable, and a trader can go through a string of losses that can wipe out his account. Loss has to be prevented if a trader is to be profitable. In order to do this, traders risk manage.
A trader who risk manages, thinks more about how to prevent loss instead of becoming obsessed with the potential reward. This trick is more effective because rewards don’t need to be managed. They take care of themselves. Risks however do have to be managed, so as to prevent losing to the point of a dry account.
Another bonus to risk managing is that it also helps with emotional management. Money management and emotional managing are not separate skills in Forex trading. They work together. A trader that has developed good money managing skills by thinking risk first is emotionally prepared for lose. They know where to set their stop loses as well as prepare for unexpected economic events and financial uncertainties. The more prepared you are for a bad trading day, the less nervous and anxious you’ll be while trading.
Thinking risk first also helps a trader to emotional manage for when they have gains. A trader who trades because of the rush they feel when they win is at risk of becoming a gambler. This type of trader can easily wipe out their account from overtrading as they try to keep up that high feeling. But traders who money manage can learn how to deal with their emotions when they are in winning mode. They do this by paying careful attention to how they feel when they win, and then take steps to control their emotions, so they can prevent themselves from getting over excited.
They also use their money management skills to develop strategic trades that have an edge. Strategic traders are less likely to be emotional because they are not relying on luck. This gives them more control over their losses and gains, which helps curb the highs and lows emotional traders experience. Strategic traders carefully consider the potential risk for each reward.
Money management and emotional management should be used together to make you a profitable trader. To help develop your money management skills focus more on the risk involved in each trade and how to prevent loss.