6. Introduction to Risk Management

Introduction to Risk Management

Module 6 – Stock & Forex Trading Basics

6.1 What Is Risk Management?

Risk management is one of the most important skills every trader must learn. At its core, it is about identifying what could go wrong in a trade and taking steps to reduce the damage if it does.

Trading will always involve risk — there is no way around it. What separates a professional trader from a gambler is not avoiding risk, but managing it intelligently. Successful traders accept losses as part of the journey and focus on controlling them so one bad trade never wipes out their account.

6.2 How Risk Management Works in Stock Trading

In stock trading, risk management is applied through clear rules that protect your capital when the market moves against you.

The goal is not to eliminate risk completely, but to:

Reduce potential losses
Protect trading capital
Maximise long-term returns

Good risk management starts with understanding:

What you are trading
Why you are entering a trade
How much you are willing to lose
When to exit if the trade fails

6.3 Key Risks Stock Traders Should Know

Liquidity Risk

Liquidity refers to how easily a stock can be bought or sold without causing major price changes. Low-liquidity stocks can have wider spreads and delayed execution, increasing trading risk.

Broker Risk

This includes platform stability, execution speed, security, and reliability. Choosing a trustworthy broker is a critical part of risk management.

Market Risk

Market volatility caused by economic events, political news, or global uncertainty can impact stock prices regardless of company performance.

Country and Social Risk

Political instability, economic issues, or social unrest in a company’s home country can negatively affect stock prices.

6.4 Practical Ways to Manage Risk

Using Leverage Carefully

Leverage can amplify profits but also magnifies losses. Beginners should use low leverage and fully understand potential downside risk before entering trades.

Proper Trade Allocation

Only risk a small percentage of your total capital on each trade. This protects your account and improves long-term consistency.

Setting Stop Losses

Stop losses automatically close trades at predefined levels, limiting losses and reducing emotional decision-making.

Taking Profits

Locking in profits at planned levels helps avoid greed and protects gains from sudden market reversals.

6.5 Understanding the Risk-Reward Ratio

The risk-reward ratio compares potential loss to potential gain. A balanced ratio helps traders stay profitable even if not all trades succeed.

6.6 Why Every Trader Needs a Trading Plan

A trading plan defines your rules for entry, exit, risk, and position sizing. Combined with a trading journal, it builds discipline, consistency, and continuous improvement.