Risk Management

1. Definition

Risk Management is the process of identifying, analyzing, and mitigating uncertainty in investment decisions. It is not about avoiding risk entirely, but about managing it to ensure survival. * Golden Rule: Capital preservation is the first priority.

2. Core Strategies

2.1. Diversification (Asset Allocation)

"Don't put all your eggs in one basket." Spreading capital across different asset classes (stocks, bonds, commodities) that are uncorrelated reduces the overall volatility of the portfolio.

2.2. Position Sizing

Determining how much capital to allocate to a single trade. A common rule is the 2% Rule: Never risk more than 1-2% of your total account equity on a single trade. * This prevents a string of bad luck (losing streak) from wiping out your account.

2.3. Stop-Loss

A pre-determined exit point to limit losses. It is an automatic mechanism to protect you from your own ego and hope. * Mantra: "Cut your losses short and let your winners run."

2.4. Hedging

Using financial instruments like Options or Futures to offset potential losses in your main portfolio. (e.g., Buying Put options as insurance against a market crash).

3. Psychological Risk

The biggest risk often comes from the trader's mindset. * FOMO (Fear Of Missing Out): Buying at the top due to greed. * Revenge Trading: Trying to win back losses immediately with larger, riskier bets.

4. The Kelly Criterion

A mathematical formula used to determine the optimal size of a series of bets. In practice, traders often use "Half-Kelly" to reduce volatility and emotional stress.