Managing Risk

managing risk

I write a lot in the blogs and on twitter about MONEY / RISK MANAGEMENT and using proper MONEY MANAGEMENT and ACCOUNT MANAGEMENT controls.

The amount as a rough rule of thumb to decide the maximum percentage of total account assets that one is prepared to risk per trade is between 0.5% and 1.0%

 Discipline Has Two Big Benefits

Firstly, it prevents “heavy/big losses” occurring from any single trade since the size of each position would be set to fit within the maximum percent risk of total equity that you have listed in your TRADING PLAN.

Secondly, this discipline prevents continued “heavy/big losses” during an extended streak of loss making trades. It can happen, and it is awful to experience, but if you trade consistently with discipline, you prevent your account suffering massive losses that can wipe out your account very quickly.

From your TRADING PLAN, you will already have your risk in pips calculated and your entry and stop and lot size estimated.

TRADE EXAMPLE:

  1. Let’s assume for the purpose of an example that you have already decided in trade plan that risk tolerance is 1% of total equity per trade placed. Your account has a balance of $10,000.00. That means that your risk = $100.00.
  2. The trade in question that you are considering requires at 47pip stop loss to meet the pivot points or Fibonacci levels. That will offer support to the trade, and by you TRADING PLAN these are your trading parameters.
  3. Trading Standard lots = 47pips x $10.00 = $470.00 – this trade is not possible within your TRADING PLAN guidelines.
  4. What do you do next? The great flexibility for Forex trading is that you can adjust your trade size to fit the risk. There are three values for the three lot sizes available. Standard Lots at $10.00 each
  5. Mini Lots at $1.00 each
  6. Micro Lots at $0.10 cents each
  7. Instead of approaching this trade with Standard lots, look at the lot size lower. Trading Mini lots at a value of $1.00 each give you the following opportunity:

($100 / 47 = 2.12 lots maximum to meet your risk tolerance of $200 for this trade example)

Therefore if you take this trade with 2 x Mini lots your maximum risk based on a 47 pip stop is 2 x 47 =  $94.00 (under the 2% / $100 risk tolerance as per your TRADING PLAN).

(In the coming weeks in the PREMIUM SERVICE blog…this example will be expanded, as I will write about the benefits of a multi-broker approach to trading)

The decision whether to enter a trade becomes a simple question of risk-to-reward ratio. As I have written many times, before I enter in trade, I know what my risk is first before I even place the trade with my broker.

Many traders will write a “winning percentage,” I hate the words winning and losing. A Trading is not similar to being in Las Vegas. You are a RISK ASSESSOR, you have loss-making trades, and you have profitable trades, it is NOT gambling like sitting at a roulette table in Las Vegas.

Now, please don’t misunderstand me, your percentage of profitable trades is important to know, but it is NOT a sign of how good your trading strategy is. The strategy defines success, and success equals $$$$. Using percentages to determine success or failure in the trading can make you focus on recent trades only. You could lose sight of the big picture, and this lead to overconfidence and departure from your TRADING PLAN and, the strict discipline guidelines, and this could lead to “revenge” or “desperation” trades.

Longer-term traders can run the risk of developing the rather destructive habit of wanting to be right rather than being successful. To this end, many of the traders will take profits off the table early to be right and achieve a profitable trade rather than letting the successful trade run. The habit can also lead to letting loss-making trades run too far away, you move stops and break your TRADING PLAN guidelines for the trading.

In my book, there is only one way to measure trading success and that sustained profitability honestly.

That is why having the TRADING PLAN detailing a RISK AND ACCOUNT MANAGEMENT plan with discipline is an essential part of any successful trading strategy, without one, in my opinion, sustained profitability is virtually impossible.

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THE SCIENCE OF MAKING MONEY WITH CONSISTENCY