In Ways to Manage Risk (Part Two), we build on the essential tools from Lesson 4 — like stop-losses, position sizing, and personal loss limits — by exploring more advanced techniques that help you manage uncertainty and protect your account, especially in volatile markets or when you have multiple open positions.
1. Diversification
Diversification means spreading your risk across different markets, asset classes, or instruments, rather than concentrating all your trades in one area.
- Reduces the impact of one trade or market going wrong.
- Example: Instead of having five trades on tech stocks, you could diversify across forex, indices, and commodities.
- Don’t over-diversify — too many trades can be hard to manage and dilute your edge.
2. Correlation Awareness
Just because you’re trading different markets doesn’t mean you’re diversified. Assets often move together — or in opposite directions — due to correlations.
- Positive correlation: EUR/USD and GBP/USD often rise or fall together.
- Negative correlation: Gold and the US dollar often move inversely.
- Use a correlation matrix or check recent price behaviour to avoid doubling your risk without realising.
3. Trailing Stop-Losses
A trailing stop-loss automatically adjusts as the market moves in your favour, locking in profit while giving the trade room to grow.
- Example: You buy a stock at $100 and set a trailing stop of $5. If the price rises to $110, your stop moves to $105.
- If the price reverses and hits $105, your trade closes with a $5 gain.
- This method allows you to follow trends while limiting downside risk.
4. Using Margin Responsibly
Trading with margin means using borrowed funds to control a larger position than your actual capital allows. While it magnifies gains, it also increases risk.
- Always understand your margin requirements and how much leverage you’re using.
- Higher leverage increases your exposure and can result in larger losses.
- Tip: Treat margin as a tool, not a license to overtrade. Use it conservatively, especially when volatility is high.
5. Hedging
Hedging involves opening a second position to offset risk in your original trade. This can be done using a correlated asset or derivative (like an option).
- Example: If you’re long on EUR/USD and concerned about short-term downside, you could short a correlated currency pair.
- More advanced traders may use options or CFDs for partial hedging.
- Note: Hedging reduces profit potential, but provides protection in uncertain conditions.
The techniques covered in Ways to Manage Risk (Part Two) are designed to help you navigate complex trading conditions, enhance your strategy, and reduce exposure to unexpected market events.
Lesson Summary
- Diversify across different instruments to reduce single-market exposure.
- Check for correlations between your trades to avoid unintended concentration risk.
- Use trailing stops to secure profits as the market moves in your favour.
- Be conservative with margin — high leverage can accelerate losses.
- Consider hedging as a risk buffer when volatility or uncertainty increases.