Trading Strategies: Traders Guide: How to Identify Low Risk Trading Strategies?
There are some strategies, like dynamic strategies, which have a relatively higher win-loss ratio and a high average win-loss ratio.
Trend following trading strategies, on the other hand, have more losses than gains, but a much higher average gain compared to the average loss.
One cannot trade both strategies with the same amount of rupee risk. Trading the trend following system with the same risk per trade as a momentum strategy would clear the trader’s account faster.
Understand the risk
This brings us to the point of understanding risk. The ability to take risk may differ from trader to trader, but the important point is to appreciate the risk per trade and take precautionary measures.
Without going into individual setups, an easy way to measure risk per trade is to risk no more than one percent of your trading capital per trade.
So, if someone has a trading capital of Rs 5 lakh, the risk per trade would be Rs 5,000 per trade. Many professional traders are comfortable with 0.5% risk per trade.
Despite such low risk per trade, it is important to trade strategies that provide an edge, so even if you have a low win-loss ratio, trades that work will yield much higher gains and improve the average win-to-loss ratio mean. .
Find the low risk area
Essentially, in order to improve their profitability, the trader should look for points that offer low risk trading with high reward.
These would be points from which the stock or index moves in the direction of the trader’s bet. The search is then limited to finding the areas with the lowest risk. This area may vary from trader to trader.
For a trader who follows the Price Action type of trading, which involves trading based solely on price candles, support and resistance provide the best entry points.
If in an uptrend the price has corrected into a support zone, this point offers the least risky entry point.
Since the trend is positive, the trader takes a position in line with the trend and therefore has a tailwind supporting his trade. Also, a support zone is a place where the price stopped earlier before moving away.
Even if the trade does not work out, the loss will be small, but if it moves in its favor, the reward will be much higher compared to the loss.
A similar argument can be made for short selling, where the area of lowest risk is the resistance zone.
For traders who are comfortable with indicators, there are many areas where a low risk trade can be taken.
For example, a trader uses a moving average, say a 50 period or a 200 period (the period of the moving average is irrelevant).
In this case, when the price touches the moving average and stops or makes a candle suggesting a reversal, a trade can be initiated above or below the candle, depending on the previous trend.
The bounce does not have to happen in a single candle. The price may hover around these important areas for a while before moving in the predicted direction. Here too, the trade offers an excellent risk-reward opportunity.
Similarly, other indicators like the RSI can be used to catch the momentum trade, where a trade can be entered when the RSI value crosses 60 to take a long trade or below 40 in the case of a short trade. . Any indicator can be used to identify these low risk trading opportunities.
In order to improve the probability of the strategy and further reduce the risk per trade, the trader can use multi-timeframe analysis.
Let’s say, in the case of a Price Action trader, a support or resistance area is identified on a weekly or monthly timeframe, then one can zoom in to the trading timeframe which can be daily or hourly.
Taking trades around these areas offers much better risk-reward trades.
Similarly, for indicator-based traders, a long position can be initiated if the stock is trading above an RSI value of 60 in the longest timeframe, then select the entry point when the RSI crosses 60 in a shorter period.
Lower risk is a factor that traders are constantly working on. Identifying areas or points that offer low risk bets can be combined with multi-period analysis to improve the risk-reward ratio.
To be a successful and consistent trader, it is important to be versatile. Position sizing and risk management must be combined with a strategy that offers a good risk-reward ratio.
A point worth mentioning here is that trading is a game where the law of large numbers works wonders. There may be times when the strategy won’t work, but over a longer period of time it will pay off.
The author is president of TradeSmart.