TYBFM

Sem-V
Prof Name: Mallika.R
Unit-04 Risk Management, Trading
Psychology and Trading Strategies
Meaning of Risk Management:

Risk management is the identification,

evaluation, and prioritization of risks
followed by coordinated and
economical application of resources to
minimize, monitor, and control the
probability or impact of unfortunate
events or to maximize the realization
of opportunities.
Risk Management
• Risk management helps cut down losses. It can also help protect a
trader's account from losing all of his or her money. The risk occurs when
the trader suffers a loss. If it can be managed it, the trader can open him
or herself up to making money in the market.
• It is an essential but often overlooked prerequisite to successful
active trading. After all, a trader who has generated substantial profits
can lose it all in just one or two bad trades without a proper risk
management strategy. So how do you develop the best techniques to curb
the risks of the market?
Risk Management Cont…
• KEY TAKEAWAYS
• Trading can be exciting and even profitable if you are able to stay
focused, do due diligence, and keep emotions at bay.
• Still, the best traders need to incorporate risk management practices to
prevent losses from getting out of control.
• Having a strategic and objective approach to cutting losses through stop
orders, profit taking, and protective puts is a smart way to stay in the
game.
Risk Management Cont…
• Planning Your Trades
• As Chinese military general Sun Tzu's famously said: "Every battle is
won before it is fought." This phrase implies that planning and
strategy—not the battles—win wars. Similarly, successful
traders commonly quote the phrase: "Plan the trade and trade the plan."
Just like in war, planning ahead can often mean the difference between
success and failure.
• First, make sure your broker is right for frequent trading. Some brokers
cater to customers who trade infrequently. They charge high commissions
and don't offer the right analytical tools for active traders.
Risk Management cont…
• Stop-loss (S/L) and take-profit (T/P) points represent two key ways in
which traders can plan ahead when trading. Successful traders know
what price they are willing to pay and at what price they are willing to
sell. They can then measure the resulting returns against the probability
of the stock hitting their goals. If the adjusted return is high enough, they
execute the trade.
• Conversely, unsuccessful traders often enter a trade without having any
idea of the points at which they will sell at a profit or a loss. Like
gamblers on a lucky—or unlucky streak—emotions begin to take over
and dictate their trades. Losses often provoke people to hold on and hope
to make their money back, while profits can entice traders to imprudently
hold on for even more gains.
Techniques of Risk Management
• Risk management is the foundation of a successful trading system. We can
basically break risk management into 3 categories:
• Risk protection
• Risk profile
• Active Trade management
 Techniques of Risk Management
• Risk Protection
• In order to protect against something it is necessary to begin with an understanding of what it is
that you are protecting against. It is fine to say that protection is being taken against potential
loss. Losses are inevitable part of the trading game. We need to accept losses as cost of doing
this business. World’s best traders too lose a lot.
• The underlying root cause of a loss in any particular trading situation is the trader’s own fear
and greed.
• Fear
• Fear warns you that something doesn’t feel right about a trade that you took; you have to try to
figure out what exactly is going wrong
• Any fear that does exist works in two ways.
• There is the fear of missing an opportunity (FOMO)
• There is also the fear of incurring a major loss
• The protection against each is somewhat different.
 Cont…
• Protection against Fear of missing an opportunity (FOMO)
• How it affect our trading
• The fear of a missed opportunity may result in a premature trade. What most of us
do We’re so afraid of missing a profit that we tend to constantly trade too early.
• The common mistake made here is to conclude that a little bit of a wait is no
problem because the eventual result will justify it. How do you know it’s going to
be just a short wait? That’s an assumption.
• A much bigger problem, however, is that the judgment (upon) which the trade is
based may be invalid. Because that opportunity has not had a chance to fully
develop. That means something could go wrong. If it does, the position will
probably be stopped out.
Cont…
• HOW TO PREVENT Fear of missing an opportunity (FOMO)
• Unfortunately there is no mechanical tool that will invariably keep you from trading too
early.
• Protection against the fear of missing an opportunity is discipline and confidence on your
method
• 4 Steps for Disciplined Trading:
• Take direction from the market, not from your hopes, greed or fear. Most traders do not see
the market clearly. Control your beliefs about the market
• Predefine your risk before taking a trade
• Cut your losses without hesitation
• Use a systematic money management plan
Components of Risk
Management
Tools of Risk Management
1.Stop Loss Order
• Stop loss order
• A stop-loss order is an order placed with a broker to buy or sell a specific
stock once the stock reaches a certain price. A stop-loss is designed to limit an
investor's loss on a security position. For example, setting a stop-loss order for
10% below the price at which you bought the stock will limit your loss to
10%.
• How to place a proper stop loss order?
• Step 1 =Identify the structure of the markets
• Step 2 = Place your stop loss beyond the structure
1. Stop loss order
• This is an interesting tool which investors can use to limit their losses in a
market rout. For instance, if you had bought 100 shares of ABC Ltd at Rs 250
and it rises to Rs 265, you are looking at a gain of Rs 1,500. But you are
worried that if the market falls, you could lose the entire gain of Rs 1,500 and
even more. To mitigate such type of risks, you could put a stop-loss order,
wherein you ask your broker to sell the stock once the price falls to a certain
level, known as the stop price, say Rs 255, in this case. So, at this juncture,
your stop-loss order become a market order, and you will sell at the next
available price at Rs 255. In this case, probably you would lose your gain but
definitely not your capital.
2. Trailing stop order
• A slight variation of stop loss is called trailing stop order wherein the sell
order will trigger if share price falls below a certain percentage. For instance,
if ABC’s share is trading at Rs 250, you could place an order to sell if the
share price falls 10% to Rs 225. If ABC’s share price rises to Rs 260, your
trailing stop would still be 10%, but the selling price would rise to Rs 234.
3. Limit order
• The issue with market order and stop loss order is that sometime share prices
could move significantly between your order time and the time the trade is
executed. To overcome this risk, the concept of limit order comes into picture.
A limit order allows you to specify the maximum or desired price at which
you will buy a share and the minimum price at which you like to sell. But,
please note that your order will not be executed unless that price becomes
available.
4. Stop limit order
• This combines the protections of a stop loss order and a limit order. With a stop limit
order, you can specify a point at which you would like to sell—the stop—as well as
the lowest price below the stop that you will accept. For instance, if you have a
stop-loss order at Rs 255 for ABC shares, you could add a limit of Rs 253. This
means you would take any price from Rs 253-Rs 255. If the stock goes below that
range, you will have to hold until the price hits Rs 253. Broking firms charge the
same amount as commission irrespective of your order types. All types of orders
have time, and most are day orders which means that they are good only for the day
you place your order.
• To conclude, for majority of the long-term investors in a reasonably calm market, a
market order is fine. But, stop orders can trim your losses especially when the
market is in a downturn and using the limit order to buy can help you grab the
bargains when the market has sold off.
5. Profit Booking
• Profit booking, also known as profit taking is when individuals or
companies liquidate their holdings to cash out the profits that they have
created. It must be understood that for a situation to be called profit booking,
there has to be a profit involved. If stocks are liquidated and cashed out to
avoid losses, then such a situation cannot be called profit booking
6. Analyze Risk – Reward Ratio
• The risk/reward ratio helps investors manage their risk of losing money on
trades. ... The risk/reward ratio measures the difference between a trade
entry point to a stop-loss and a sell or take-profit order. Comparing these two
provides the ratio of profit to loss, or reward to risk.
Do’s and Don’ts in Trading
• 1) Forget the news, remember the price
• 2) Buy at Support, Sell at resistance
• 3) Don’t chase momentum if you can’t find the exit
• 4) Trends test the point of last support / resistance
• 5) Trade with the TICK not against it
• 6) If you have to look, it isn’t there
• 7) The trend is your friend
Do’s and Don’ts in Trading cont..
• 8) Avoid the Open
• 9) Bulls live above the 200 day, bears live below
• 10) Price has memory
• 11) Big volumes kill moves
• 12) Trends never turn on a dime
• 13) Bottoms take longer to form than tops.
• 14) Beat the crowd in and out the door
 Rules For Stop Loosing Money
• 1. Don’t trust others opinions • 8. Don’t chase the crowd
• 2. Don’t break your rules • 9. Don’t trade the obvious
• 3. Don’t try to get even if lose happens • 10. Don’t ignore the warning signs
• 4. Don’t believe in a company • 11. Don’t count your chickens
• 5. Don’t seek the Holy Grail (a thing which is • 12. Don’t forget the plan
eagerly pursued or sought after)
• 13. Don’t join a group
• 6. Don’t forget your discipline
• 14. Don’t ignore your intuition
• 7. Don’t trade over your head
• 15. Don’t hate losing
• 16. Don’t project your personal life
Importance of Discipline in Trading
• Overtrading is the biggest reason for failure of people in trading while there is no
definitive rule how many times you can trade, new traders should be especially
cautious not to overtrade.
• Why do traders overtrade?
• 1) Because of they are hooked on the rush that comes from being in the markets.
• 2) They feel that they will miss a golden opportunity if they don’t trade
• 3) System does not have specific enough entry criteria
• 4) hurry to start , traders don’t wait for a good opportunity
• 5) They feel more they trade, more they earn
 Importance of Discipline in Trading- Learning to
identify the best market opportunities
• Three Positions: • Improvement Points
• A) Long • 1. Stick to your Guns
• B) Short • 2. Set stop loss and take profits
• C) Flat • 3. Don’t watch minute to minute
• 1. Trading Discipline • 4. Eliminate high probability trading
• 2. Understanding risk • 5. Accept that full –time day trading is
rough
• 3. Stick to your niche
• 6. Don’t get attached
• 4. Look at every time frame
• 7. Pick swing traders or day traders
• 5. Trading is affected by emotions
• 8. Talk to others traders.
• 6. Trade as your capital allows
Day Trading – Day Traders
• Day trading is a form of speculation in securities in which a trader buys and
sells a financial instrument within the same trading day, such that
all positions are closed before the market closes for the trading day to avoid
unmanageable risks and negative price gaps between one day's close and the
next day's price at the open
 Risk Associated with Day Trading

• 1) Lack of Risk Management

• 2) Lack of, or an Improperly Tested Strategy.
• 3) Your Broker
• 4) Your Technology
• 5) Lack of Order Knowledge
• 6) Yourself, Your Tendencies and Your Personality
• 7) Final word on knowing Just enough to be Dangerous.
 Advantages of Day Trading

• 1) No Overnight Risk • 6. You are in cash at the beginning

and end of day.
• 2) Day traders can make profit in any
direction • 7. Less Risky
• 3) Increased Leverage more buying power • 8. You can do more trades.
• 4) High Returns • 9. Better learning opportunities.
• 5) Low Brokerage Commission • 10. Don’t have to do much study
Techniques of Day Trading
• 1. Trend following • 6) News Playing
• 2) Container investing • 7) Price Action
• 3) Range Trading
• 4) Scalping
• 5) Rebate Trading