Beginner Trader's Guide: Managing Money and Risk

Beginner traders, or those who have just started with online trading or are about to do so, represent the most vulnerable category. The risk of losing money, and thus abandoning speculative investment activity forever, is high. After all, the percentage of traders who end the calendar year at a loss is 85%, and many of these are beginner traders. Beginner traders, however, have more than a glimmer of hope for success. Also because everyone, even those who earn a lot of money today, were beginners at the start. For their hopes to be greater than zero, though, they are faced with a difficult task: learning to manage money and risk. That is, learning and putting into practice money management and risk management. Complex but irreplaceable disciplines, they consist of various actions and precautions that represent a kind of insurance for the trader. The issue is quite thorny when it comes to beginner traders. They should in fact adopt a particular variant of money management and risk management, capable of responding to the needs of those who have just started.

Why Money Management and Risk Management

Money management and risk management represent two disciplines to be exercised regardless of the type of trading and the degree of experience of the trader. Whether a beginner or an expert, active in low volatility markets or high volatility markets, money management and risk management should be an integral part of trading activity. As already mentioned, they represent a sort of life insurance. Often, especially when the market or economic environment is in bad waters, they constitute one of the few barriers available to traders. Trading while ignoring these disciplines, therefore, is pure financial suicide. To understand their importance, however, it is good to provide, for the use of beginners, some concrete reasons demonstrating the essentiality of money management and risk management.

Online Trading is Too Risky an Activity

It is a truth that all trained traders know. In theory, beginners know it too. However, it is necessary to trade to experience firsthand the risky nature of this activity, to have a complete and realistic idea of it. Now, if the risk is high, it is impossible to think of acting without taking precautions, without a kind of lifeline that, even if the ship were close to sinking, is able to guarantee safety. Here, money management and risk management are exactly this: a tool to hurt oneself as little as possible when things do not turn out as hoped. Obviously, they are not only this, but they mainly serve this function.

They Represent First and Foremost a Forecasting Tool

Why are money management and risk management so effective? The answer is not univocal. Here we report the most immediately understandable one: they allow you to visually see how much you risk losing and how much you can gain. Therefore, a trader who wields the weapon of money management and risk management with knowledge of the facts, always has a clear idea of what would happen to him in case the trade went wrong and in case the trade went well. All this, in a risky activity like trading, has dramatically positive effects.

They Generate a Feeling of Control Over One's Finances

This third element is a corollary of the second. If the trader knows in advance how much he could lose and how much he could gain, it means that he can organize the trade according to, at the very least, the maximum sustainable loss. In this way, he has the feeling of having full control over his finances. A feeling that, if money management and risk management are practiced diligently, corresponds to reality. This sets in motion a whole series of negative consequences, a real domino effect. If a trader feels he has full control over his finances, he feels less anxiety and certainly does not risk panicking. Consequently, if his emotional state improves, performance also improves. It's okay to act under stress (which within certain limits is positive) but intense anxiety and panic always compromise the quality of action.

The Typical Risks of Beginner Traders

As we have already mentioned, money and risk management represent a common asset for all traders, regardless of their level of experience. Beginners, however, constitute a special category, with needs that are partly different from the rest of the trading community. Needs that concern, obviously, precisely the issues of money management and risk management. In short, they present some specificities that make it necessary to rework classic money management and risk management. That is, a sort of integration, not so much from the technical side as from the approach. We will address this specific topic in the next paragraph. In this one, to give a realistic idea of the conditions of beginners, we present the specificities of beginners in relation to money and risk.

Poor Risk Perception

Are beginners reckless? Not necessarily, at least not at a conscious level. Certainly, if they have undergone a training course worthy of the name, they are aware of the risks associated with trading. However, as mentioned a few lines ago, the real perception of risk is acquired only through practice. One thing is to know a danger, another is to experience it. So very often beginners, even without wanting to, behave in a less prudent manner than experts. It obviously depends on the character of each trader, but it is still a paradox: the beginner, who has fewer tools at his disposal to defend himself, risks more than the experienced investor.

Insufficient Financial Availability

It is rare for a beginner to start online trading with a high capital. Also because it is likely that the "high capital" represents the goal, rather than the starting condition. This, however, increases the risk that the trader will assume inappropriate behavior. If the capital is low, even any gains (in absolute terms) are low. Therefore, he will tend to be more exposed. The danger then is to act in an imprudent manner almost without realizing it. Money management and risk management have precisely the function of preventing this drift.

Poor Emotional Stamina

This is a big problem, perhaps the biggest problem that can involve a beginner trader. It's not just a matter of character. A determining factor is experience. The novice may also be endowed with a solid personality, with a marked resistance to stress, but in the early stages of his career he will always be at risk of emotional imbalance. Some skills, very simply, develop. Now, if emotional stamina is weak, as it is in the vast majority of cases, there is a strong tendency to make both operational and strategic mistakes, precisely due to the lack of clarity determined by emotional upheaval. Mistakes that also and above all concern money management.

Tips for Beginner Traders

The 2% Rule

It is a sacred rule, however arbitrary. However, it should be followed in the "absence of better", that is, if concrete money management strategies have not been developed, which therefore remains at a basic level. The 2% rule suggests being exposed, for a single trade, for an amount never exceeding 2% of one's account. If for example there are 5000 euros in one's account, the trade should not represent an investment of more than 100 euros. The reason? By adopting this pace, before ending up on the breadline, one should lose 50 trades in a row. Furthermore, by adopting this rule, it is possible to use leverage up to 50% before ending up in the red (but this is an extreme case). As already mentioned, it is an arbitrary rule. More than appealing to technique, it appeals to common sense. For this reason, if you are a beginner trader and do not yet practice advanced money management, you should follow it.

The Question of Lots

Many brokers allow, or even require, organizing one's exposures in lots. A lot is equal to 100,000 euros, but there are also mini lots and micro lots, which design exposures even lower than 1000 euros. Why is it good, when possible, to refer to lots? The reason is simple: in a certain sense, they remove from the discretion of the individual trader the question of exposure. They exonerate him (in part) from the decision of deciding how much to invest per trader. Notwithstanding that the 2% rule must be considered a priority, "trading by lots" can be taken into consideration to reduce one's decision-making power. It may seem paradoxical but, especially in the early stages of trading activity, it is a positive thing.

Attention to Financial Leverage

Financial leverage is a very particular tool, able, by itself, to attract laymen and push them to trade. For those who don't know, financial leverage is the tool that allows you to increase exposure in a fictitious way. If, for example, a 10:1 leverage is used, if you invest 100 euros and obtain a 1% return, you will not get a gain of 1 euro, but a gain of 10 euros. In short, it's like trading by investing 10 times what you actually invested. There is, however, a flip side, and it's a very heavy one: gains increase, but so do losses. At this pace, it is easy to reach the zeroing of the account. Now, beginners tend to abuse leverage for a simple reason: they start from a low capital, so the gains are always meager. The advice, obviously, is to think twice. If you are really determined to use leverage, it is better not to settle for 10:1 leverage.

Stop Loss Setting

Setting stop losses is a typical action not so much of money management, but of risk management. Although, in reality, the two disciplines are in this case heavily interconnected. It is precisely by virtue of the stop loss, in fact, that one can preventively identify the maximum loss that that particular trade can cause. Now, beginners generally have some problems setting stop losses. They tend, precisely because they are anxious to increase their capital, to keep positions open for too long. So they often set very wide stop losses. The advice to follow is exactly the opposite: since in the initial phases the success rates are low by definition, it is good to set stop losses in a prudent manner. Between the wide approach and the narrow approach, it is always better to prefer the latter. It is a difficult choice to make, as it gives the perception of walking at too slow a pace, but it is necessary to preserve capital in a crucial phase such as the beginning.