As a professional or aspiring trader, proper risk management should always take precedent as your primary tool for protecting yourself from losses. While this isn’t true of all newbie traders, the vast majority will dive head first into trading without a proper risk plan and will either risk too much leading to a huge win or huge loss, and if they continue to risk too much, it usually ends in a blown account!. This is obviously something we want to avoid. Proper risk management is best practiced in a demo account so you can get familiar with the process and build a habit of properly sizing your risk before you put real money on the line.
This article will cover everything you need to know to get up to speed on proper risk management and we’ll also give you some tips and tricks for accepting risk (trade psychology), and our favorite risk management tools that we use when we trade. Whether you trade stocks, FX, or cryptos, what is mentioned in this article will transfer over, so be sure to read it and really understand it.
Our Free 5-Part Risk Management Training On Youtube
Before we dive in, I’ve also put together a 5 part risk management training video which you can watch on YouTube for free! This risk management series is also included in the Phantom Trading course because it’s such an important lesson because it’s a subject that is often overlooked, while being the most important tool in a professional traders tool box for preserving capital and maintaining consistency in the long run without blowing up their account.
You can watch the free 5 part risk management video series on YouTube here!
What Is Risk Management For FX Traders?
Risk management is actually quite simple when we get down to it. For forex traders, the learning curve is a little higher because you are dealing with lot sizes instead of shares or number of coins or tokens in the crypto market – but not to worry, we’re going to cover all of that and more. If you don’t know what lot sizes are, you can learn more about it in part 3 of our forex beginners guide, under the “Lot Sizes (Position Sizing) section!
So how do we manage risk as traders in the forex market? It’s as easy as deciding how much of your total account equity you’re willing to put on the line per trade (usually anywhere from 0.5% – 1% per trade) and using a lot size calculator to figure out how many lots you should put onto a trade based on the size of your stop loss. Remember, the smaller your stop loss, the bigger your lot size is because it’ll take fewer pips for the trade to go into the negative before hitting your stop loss order (technically more exposure with bigger lot sizes, but you’re generally protected by your stop loss).
Aside from entering trades, we also want to stick to consistent risk sizing by risking only up to 1% of our total account equity as to keep our risk of ruin low. We’ll cover more on this later in the article so don’t worry!
The Basics of Risk Management
The absolute basics of risk management consists of understanding how compound interest works, picking a risk profile/system, using a lot size calculator for trading in the Forex market (or manually calculating shares in the stock market / number of coins or tokens in the crypto market) to keep your risk per trade consistent, and sticking to your risk management plan.
Managing risk is really as easy as following the rules you have set out for yourself in your risk plan so you don’t go around risking more per trade and potentially grenading your account. For those who are less experienced on the trade psychology end of things, this can come as a challenge, but it’s something that should be corrected early on so as not to build up bad habits!
Last but not least, we want to also consider putting rules in place to prevent us from revenge trading in the event of a bad day. While this may not be necessary for some traders, it’s still a necessary failsafe that should be put in place to prevent you from overtrading. In my case, it’s as simple as stopping trading after I hit 2 losses or 2% draw down on the day. It means I shut off my MT4 and go do something else so I’m not tempted to try to recover my losses for the day with subprime trade setups and get even deeper into drawdown.
How Compound Interest Works (Compounding Returns)
I want to make a quick clarification before we start on this section. This isn’t compound interest persay, but risking a consistent percentage of your total account size every trade operates on the same principle which is why I’ve titled it as such. We can think of trading more as “compounding gains” rather than interest because we’re not just throwing money into a savings account with an interest rate and watching it grow… we’re trading it!
The idea is that if you start with say a $100,000 account, and get a few 5R trades risking 1% of your total account equity per trade, your risk will naturally scale up to 1% of your account equity as it grows, allowing it to compound the same way compound interest works in a savings account works at your bank.
| Trade # | % Risk Per Trade | $ Risk Per Trade | % Gain | Account Balance |
| 1 | 1% | $1,000 | +5% | 105,000 |
| 2 | 1% | $1,050 | +5% | 110,250 |
| 3 | 1% | $1,102 | +5% | 115,760 |
| 4 | 1% | $1,158 | +5% | 121,548 |
As illustrated in the table above, by risking 1% of your account equity per trade you stand to gain a total of $1,548 more than if you were just risking a fixed dollar amount (and fixed lot sizes) per trade.
Why You Need Proper Risk Management For Trading
Why is it so important to exercise proper risk management skills when trading? As mentioned several times above, it’s a matter of capital preservation so you don’t go around blowing accounts (whether it’s a personal one or a prop firm funded account). The whole point of risk management is to control our risk and let probabilities play out over a large sample size of trades in our trading system. By doing this we can ensure that we have a statistically sound risk system we’re abiding by that will give us longevity as traders in our trading career.
Without risk management you can certainly win big, but at what cost? At Phantom Trading we discourage people from taking accounts and trying to flipping them, and instead encourage traders to slowly but surely grow their account with proper risk management rules set in place from the start. While it may feel nice to put half your account on the line on a single trade and win, you’re asking to lose it all in just two trades! Remember, for every 50% loss in your account it takes an entire 100% gain to recover it back before you can hit new equity highs. This is something novice traders misunderstand, and it leads to losses that can be easily avoided.
Under no circumstance should a professional trader ever blow an account because of poor risk management. It’s not something a true trader does! If anyone tells you otherwise, RUN!
Our Recommended Position Size Calculators
Moving on we’re going to cover our personal favorite risk management tools – also known as position size or lot size calculators. If you trade forex, you more than likely use MT4/MT5 or C-Trader so we’ll be covering tools made for those trade terminals.
Magic Keys ($165 USD Normally / Get 10% off w/ Code: CDW10)
First off we have Magic Keys, and I’m only going to plug them here because I actually use their product (both the physical, and on-screen versions) with one at my work station, and the on-screen version for my Forex VPS where I run my trade copiers across several different accounts. This tool is honestly amazing because it does it all.
Sure it’s a little overpriced, but so are the other options. Also, if you ask me the free alternative I’m going to mention below works okay, but in my experience can be buggy and can hang up when you need it to work most! When you’re trying to enter a trade! Also, this one is available for you C-Trader users too, unlike the other options we’re going to list below.
If you want to purchase a physical Magic Keys unit or the on-screen one which is considerably cheaper and does the exact same thing without the physical unit they ship to you, click on our affiliate link below to purchase it now! Don’t forget to use our code to get 10% off too so you can save some money!
⬇️ Get 10% off Magic Keys On-screen or Physical w/ Code: CDW10 ⬇️
https://magickeys.trade/coldwaterfx
Trade Assistant (MT4/MT5 Only) ($100 USD)
Next we have Trade assistant which is offered on the meta trader market. This one some traders on our team swear by, and for good reason… It works well and it’s reliable. It even accounts for trade commissions by covering them when using the auto break-even function which is something I’ve been begging the Magic Keys devs to add into the next update for ages!
Unfortunately we couldn’t get a discount code because we couldn’t find a way to contact the author or the expert advisor, but we suggest renting it for 3 months which only costs $30 before dropping $100USD on it to see if you like it.
Trade Assistant never used to cost so much, and in fact it used to be free if you only activated it in demo mode, but it looks like the author hiked up the price because he knows how good his EA is. Still worth it if you’re serious about being a professional trader, if you ask me.
⬇️ Trade Assistant (MT4/MT5 Only) ⬇️
MT4: https://www.mql5.com/en/market/product/30750
MT5: https://www.mql5.com/en/market/product/23415
Earnforex.com Position Size Calculator (Free)
Last but not least we have the free alternative which comes in the form of a simple MT4/MT5 indicator + script for execution (not an expert advisor like the other options). This is a tool that I actually used for a couple years when I first started trading Forex, and it sure as heck beats using a manually online calculator or lot size position calculator app on your phone which are slow and tedious to use while trying to enter a trade.
It should be noted, as stated above this tool can freeze up or fail to execute trades in my experience, plus it’s a little complicated to install if you’ve never installed an indicator on MT4/MT5 before – but that doesn’t mean it’s not a great free alternative to use while you build up your skills by taking an online forex training course to learn how to trade while practicing on a demo account.
⬇️ Position Size Calculator (MT4/MT5 Only) (Free) ⬇️
Trading Systems (Risk Models)
In this section we’re going to cover the various risk systems or models you can use when trading so you have an idea of the minimum targets, strike rate you need to maintain, and your total loss risk (also known as risk of ruin) for each system. Each of the graphs below were created using an equity curve simulator tool by Surricate Trading which you can find here if you’d like to experiment with your own risk system.
Examples of High Risk Systems That Will Likely Blow Your Account
Examples of Healthy Risk Systems With Low Total Loss Risk
2R vs 5R Minimum Setups @ 30% Win-Rate
Conservative Beginner’s Risk System / Aggressive Risk System
Why You Should Never Risk More Than 1% Per Trade
Now that you have an idea of the different risk systems that traders commonly use, we can cover the reason why you shouldn’t be going around slapping 5%, or even 2% on a trade. It’s ultimately a huge gamble to play with higher risk, and unless you are okay with completely blowing the account we advise staying within the 0.5% – 1% risk per trade range in order to keep that risk of ruin (total loss risk) low.
Ultimately keeping your risk per trade within the safe tolerance is all about maintaining good account durability, lowering the chances of falling into a deep drawdown that is difficult to recover. By sticking to this rule you can rest easy knowing that as long as you stick to your plan and let your edge play out, there is an extremely low risk of losing the account whether funded through a prop firm or funded though your own money as a personal account!
Risk of Ruin (RoR) and Account Durability
Next let’s discuss Risk of Ruin (ROR) or total loss risk in a bit more detail. The reason we want to aim for a sub percent risk of ruin is because it means we minimize the overall probability of completely blowing our account, and thus we can prove to ourselves and those who invest in us that we have good risk management skills!
The name of the game is preserving your account and capital as much as possible. Now this of course comes with a small caveat which we’ll discuss in the last section on the psychology of accepting risk.
You know that saying, “scared money doesn’t make money”? Well there is some truth to it, especially if you’re risking too little for your account size, or if you’re afraid to enter a trade because you’re afraid of losing. It’s a more common problem than you might think!
The Psychology of Accepting Risk
Finally lets discuss trade psychology as it relates to risk management and accepting risk. We cover this in more detail within the beginners guide to trade psychology and our article on how to manage emotions while trading, but we’ll briefly touch upon it here because it’s relevant to having airtight risk management. As professional traders who are looking to make a living and career from trading we need to ensure we study our strategy and practice it by collecting data and testing it in a live market environment enough to build the confidence to enter trade setups which fit within our trading plan present themselves in the market without hesitation or fear of lowing.
Trading is an inherently risky way to make money, especially if you don’t have a proper strategy and system, or you lack the experience in the live market to be able to execute your plan with enough consistency to turn a consistent profit. That being said, not every trade can be won, and losing is just a part of the game. It’s important that we remind ourselves that trading in a way is gambling. You can lose, and that’s alright so long as you stick to your risk rules, trade plan, and you have the discipline to keep hitting valid trades without deviating from your plan – which can lead to inconsistency.
Remember, we are here to utilize our edge by letting the probabilities play out, not to pick and choose setups based on our emotions. This is what separates professional traders from novice ones.
And with that, you now have a basic idea of how to use risk management to protect yourself from unrecoverable losses!
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Robert Castillo
@coldwaterfx
FX Trader & Analyst
Writer & Editor
Rob is a funded trader from Toronto, Canada, and has been trading currencies, commodities, stocks, and cryptocurrencies for over 7 years. Outside of trading, he enjoys making music, boxing, and riding motorcycles.
