Anyone with a computer and access to the internet can make a few quid trading.
It’s only the ones who reduce their losses that become rich.
When look at trading strategies, people on focus on the winnings – cutting losses can often be the biggest way to make more money and is also the most ignored aspect.
Every investment involves risk. No matter how much research you do, there will always be uncertainties that you can’t account for.
This is why good trades won’t always make money. Luck is also a big factor. PB wins and injuries are just two instances where luck plays a big part.
Risk management occurs when you analyse and attempt to quantify the potential for losses in these investments and try to minimise them.
Avoiding large drawdowns is the same as Warren Buffett’s famous rules:
Rule No. 1: Never Lose Money
Rule No. 2: Never Forget Rule #1Embed from Getty Images
The amount of risk that you’re willing to take will vary between individuals and depends on how much money you’re willing to lose and if you will need any of it urgently.
Those with smaller portfolios should also be willing to carry larger risk if they want to make growth.
The strategies for risk management that I’m going to outline will vary depending on if you’re long term investing or short term trading.
Risk management in long term investing
Diversifying and portfolio sizing
When it comes to investing long term, diversification is the strongest weapon in your risk management arsenal.
Like we’ve said, not all good trades win. Unfortunately if one player drastically drops in price, similar players often will. In Football Index terms, it means that you should be holding players in different teams, leagues, positions, ages and nationalities.
You should also invest some of your money outside of FI. Do your own research on what you want to invest in, it could be crypto, stocks or bonds. If you’re not sure on where to get started, index funds are usually a good place to start.
You also want to spread the risk equally across each of your investments, so each of them will have similar levels of losses in worst case scenarios. This is called portfolio sizing and you may have to readjust it every few months depending on growth.
Think about maximum losses
Thinking about worst case scenarios are very important, especially if shit goes south.
It’s not about how much you are willing to invest, its about how much you are willing to potentially lose.
For example, say you have £10,000 that you’re willing to invest in FI, but only £4,000 that you’re willing to lose. You then predict that, at the very worst, your investments across all players will drop on average around 50%.
This means that you should only be investing £8,000 and not the full £10,000 as the worst case scenario exceeds your risk tolerance.
Have cash spare
Pretty simple – having cash spare reduces the amount of money you have tied up in assets that have risk and will mean that you are ready to buy when big crashes happen.
Short term trading
Less price volatility and a 2% commission makes short term trading on FI different to short term trading in traditional financial instruments.
Traditional trading can be done so that you can enter and exit positions on a ton of securities, within one day. In FI, the prices often won’t move that quickly, meaning that short term trading is often done over days and weeks rather than minutes.
This longer window for holding assets brings bigger risks. Of course, you can mitigate these by using the techniques we would use for longer term trading, while keeping in mind that the risk is usually less than that for those holds that you would keep for years.
My preferred method of mitigating the risks of short term trading is the 5% rule
The 5% rule
The 5% rule is a rule that says that for all the money you have set for trading, don’t have a position that risks more than 5% of that money.
Say you have £20,000 and plan to use half of it for investing and the rest for trading. Out of the £10,000 left, the absolute maximum that you should be losing on a single trade is £500. Ideally, you won’t ever want to reach that 5% and want to keep it at 2%.
Trading with brokers allow you to put stop losses, to get you out when you reach that number. Unfortunately, that’s not a feature of FI. This means that you will have to be disciplined and watchful, in order to sell at the price you need to sell at.
Hope you enjoyed this blog post.
I’ve been slacking a bit with the posts recently, but I’ll try to keep them regular for you guys.
If you have any topics you want me to talk about or even any questions, feel free to drop me a DM on Twitter.
Finally, with the new lockdown coming in, I hope you guys stay safe and take care of yourselves. I know things can be tough, but hopefully this should be last lockdown we go into.
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