Risk management

We talk about risk management in almost every course and that’s because it’s critical for trading success. Risk is an inherent aspect of trading, and nobody gets every trade right. Risk management is simply putting in place a set of rules and measures to make sure the effect of getting a decision wrong is manageable.

In this lesson, we’re giving a quick overview of risk management, as well as how to evaluate your trade performance to keep improving your trading.

Risk management principles

There are three main types of risk:

• Market risk: the potential to suffer loss due to movements in market prices
• Liquidity risk: the potential to suffer loss because you can't buy or sell an asset quickly enough
• Systemic risk: the potential for the entire financial system to be affected by an event or series of events

Read more about the risks of trading here, including how to protect yourself against them in the IG platform.

To manage risk effectively, there are certain principles and strategies traders should consider:

Start with a trading plan

Smart traders understand the importance of proper preparation. They rely on a trading plan to guide their trading decisions, which contains their specific goals, motivation, attitude to risk, personal risk management rules, trading strategies, and an analysis of their past trades.

A trading plan acts as your checklist for trading, helping you to take decisions without being affected by emotional state, maintaining your discipline, and learning from your trading history.

Find out more about developing a trading plan here.

Practise in a demo account

Before putting real funds at risk, consider learning the ropes in a demo account, whether you’re new to trading or looking to explore new markets or trading strategies. Demo accounts aren’t just for beginner traders.

Even if you’re an experienced trader, you might find that you tend to profit on the same type of trades and lose on the same type of trades. Using a demo trading account environment to work on markets where your trades tend to consistently underperform can help you understand why, and how to improve.

Find out more about IG demo accounts here.

Have a solid understanding of key risk management principles

• Understand potential loss: Before entering any trade, calculate your worst-case loss, especially with leveraged products, where losses can exceed your deposit. Be aware that markets can move quickly or gap, making it harder to exit at your desired level.
• Control your emotions: Avoid making impulsive, emotion-driven decisions. Stick to a structured trading plan supported by clear analysis, not gut feelings. This helps maintain discipline and reduces emotional risk.
• Diversify: Many markets can be affected in a similar way in response to a specific type of event (e.g. the dollar may strengthen or weaken against multiple currencies simultaneously in response to a change in interest rates). Diversifying by spreading your capital across a range of uncorrelated markets, either within an asset class (e.g. forex), or between asset classes (e.g. shares, commodities or indices) reduces your risk of exposure to multiple correlated markets moving against you simultaneously.

Understand the important numbers

• Set your maximum risk per trade: How much you risk on each trade will depend on your trading style and capital. A popular guideline amongst traders is risking no more than 1-2% of their account value.

• Work out the risk vs reward ratio of every trade: You can actually lose on trades more times than you win, yet be consistently profitable. It's all down to risk vs reward. To find the ratio on a particular trade, simply compare the amount of money you're risking to the potential gain.

Read more about understanding risk and reward here.

• Ensure you understand all costs and fees: Always check all costs before opening a trade, not just the market price. Fees, spreads, funding, and exposure all affect your final return. See more here.

Risk management tools

Beyond ensuring you have a firm grasp on your own risk appetite and risk management principles for trading, there are also several tools you can use to manage risk per trade.

Orders

Entry orders enable you to have positions automatically open when the market reaches a specific level. They are helpful if you’re speculating on a market trend, or support and resistance levels. You can set these in the “order” tab of the deal ticket.

Closing orders enable you to lock in profits automatically at your target if a market is moving in your favour, or cap losses if the price moves against you. You can attach these to an entry order using the “stop” and “limit” fields in the order tab. Or, you can attach them to a trade you’re about to open in the deal tab of the ticket.

Stops and limits

Stops and limits help you to set when to enter and exit positions and are an important component of risk management.

Stops (there are various types, including guaranteed and trailing stops) are an instruction to close your position when the price of a market hits a specific level less favourable than your entry price or the current market price. If, for example, you were putting a stop to close on a long position, you’d place it lower than the current market price, while on a short position you’d put it higher than the current market price.

Limits, on the other hand, are an instruction to close your trade if the market price reaches a price more favourable than the current price. In other words, you would place your limit to close above the market price on a long position, and below the market price on a short position.

Avoid common trading mistakes

Another way to manage risk is to learn from the mistakes and successes of your own trades, as well as those of others.

Here are four of the most common mistakes traders make:

1. Overreliance on intuition or emotion. Traders often fall into the trap of executing trades based on instinct or anecdotal tips, rather than data-driven analysis. While professional traders may develop market intuition over time through repeated exposure and pattern recognition, premature reliance on “gut feel” can lead to poor outcomes. Make sure you cross-reference your intuition with market research prior to making trading decisions, and stick to your trading strategy, no matter how you feel.
2. Holding onto losing positions. A reluctance to realise a loss often results in traders retaining underperforming positions longer than advisable, in the hope of market reversal. This can erode gains and eat away at your equity. The disciplined use of stop-loss and limit orders helps to mitigate this risk by removing emotional interference from trade management.
3. Overconfidence following profitable trades. Success in one or more trades may lead to overconfidence, prompting traders to deviate from their original strategy. This often results in hastily executed, inadequately analysed trades. Again, this is why it’s important to stick to your predefined trading plan.
4. Misunderstanding leverage. As we’ve touched on, leverage lets you control a large position in the market with a relatively small upfront deposit (called margin). This can amplify your profits, but also your losses. If you don’t fully understand how leveraged products like CFDs work, you could lose money very quickly

Track and improve

No matter whether you’re a beginner, intermediate or advanced trader, once you’ve placed your first trade on the IG platform, we hope you’ll continue to learn and build confidence in trading.

One of the best ways to do this is through keeping a trading diary: a written record of everything that happens when you trade, including entry and exit points, profit/loss, trading statistics and even your emotional state before, during and after each trade.

This is a useful tool for measuring your performance and improving over time.

Ready to try it for yourself? Start with a free IG demo account.