Keeping your losses small is one of the most important things you can do when trading stocks. Most people believe in order to be a professional trader you have to take big risks and never lose. This is a very farfetched tale as the people who take too big of risks in the market wind up broke and there is no such thing as a person who doesn’t lose money when trading.
One of the keys to being successful is simply keeping your losses as small as possible. By doing this you are increasing your chances of being profitable. It can also give you these five benefits.
1. Don’t go broke On 1 Trade
If you are risking too much then all you have to do is lose big once to take your account to zero. And it is simply not possible to be right 100% of the time. So if you are always risking a big percentage of your account on any one trade then you are going to be in for a shook when you experience your first losing streak.
This is even more true true if you are trading options because you can lose big here just on 1 trade.
2. Losing Streaks Do Happen
Everybody has good times and bad times. It is a fact of life, sometimes you win and sometimes you lose. The stock market is one of those places that you can lose everything during your down times. To counter this it is really important that you keep your losses as small as possible.
This way you can to lose 3 or 4 times in a row and you still have money in your account for your next big win.
3. Less often You Need to Be Right
How often do you need to be right if you make $2 every time you are and lose $1 every time you are wrong? Over a third of the time, right? With a risk to reward ratio of 2/1 you can be wrong 60% of the time and still be profitable in the long term.
That sounds pretty good, and if you are really bad at picking stocks and are only win let’s say 30% of the time then you can always increase your risk to reward to give you a profit.
4. Less Emotions
This is not taken into consideration very much by new traders. But if you have ever attempted to learn stock trading you have probably found that it is a very thing. These emotions can often times make you jump and do things that you normally would not do.
On the other hand if you are only risking a small percentage of your account on a trade, then you will not have as much emotional pressure on your shoulders this lets you make some better decisions.
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