As a new trader, you may be wondering why it’s important to manage risk. After all, aren’t the most successful traders just taking big risks and making millions?
In reality, there are many ways to manage risk as a trader. One of the best ways is to start small and grow your risk over time. If you start with a small percentage of your account on each trade and make sure that your total exposure (the combined value of all positions) is always less than 1%, then you’re likely to avoid blowing up your account.
It’s also important to remember that there are two types of risk: systematic and unsystematic. Systematic risk is the same in every trade; it’s the market risk that comes from trading against large trends. Unsystematic risk is specific to each individual trade; it includes things like the quality of your research and analysis, whether or not you’ve accounted for fees in your calculations, etc.
Risk Small And Win Big
As mentioned previously, as a new trader you’ll want to start by risking somewhere around 0.25% – 0.5% per trade (this doesn’t have to include commissions), and rather than focusing on your net profit and loss per trade, pay attention to your actually net +R (risk-adjusted return), where “R” is the multiple of the risk you have on the trade.
For example, if you risk 1% of a $10,000 USD account, you’d be risking $100 USD on a trade. If you are able to make a profit of $500 USD, that’s 5x what you initially risked on the trade or +5R.
The point we’re trying to make is that huge profits mean nothing if you’re risking half of your account to get them because your effective risk of ruin (risk of completely blowing the account) is extremely high.
Why You Should Only Risk A Maximum of 1% Per Trade or Less
So that brings us to our next point. Don’t risk more than 1% per trade, ideally risk 0.5% or even 0.25%, especially when starting out. When you’re a new trader, you can expect to go through a lot of trials and tribulations as you’re learning how to properly analyze the markets from the top down (looking at things like market structure and liquidity), all the way to actually entry models on the timeframe of your choice whether that’s the 15m, 5m, or 1m timeframe.
So if you’re learning, and expect to lose a lot, why not keep your risk low so you can absorb losing streaks, and focus again on the net +R you’re making over a large sample size of trades (20-30+ trades). This is how you’ll be able to accurately measure things like your profit factor and expectancy in your trading system.
Managing Risk & Understanding The Probabilistic Nature of the Market
What most traders don’t understand about the markets is that they are probabilistic in nature, much like rolling a set of dice. No single moment in the market is like any previous or future moment. Each moment is truly unique. Our edge as profitable traders who use a supply & demand trading strategy is simply defined by our ability to recognize patterns in the market, and to enter high probability trade setups that over time will result in a positive expectancy through a large sample size of trades.
If you haven’t already, check out our video on “How To Stop Caring About Losses” on YouTube here:
That means that like any other trading system, there will be winning and losing streaks, because the distribution between winners and losses in a system is always going to be random and completely out of our control. The only thing in our control is how we analyze and react to information in the market, as we decide whether or not a setup is worth the risk of taking in hopes of it turning into a profitable trade. We also know that any single trade, as good as a setup as it may be based on our technical analysis, can fail, and even low probability setups can work.
Risk Less & Survive To Trade Another Day
The reason you should risk a max of 1% at first is that trading is a numbers game, and limiting your risk will ensure you’re there to trade another day. This is pretty well the main takeaway we want you traders to get from this article. Managing risk in trading is like putting a seatbelt on while driving a car. You may not get into an accident or make a huge trading mistake, but if you do, you want to manage risk by putting something in place to save you if you do get into an accident, or in the case of trading, hit a losing streak.
Again, this is obviously just as important for new traders, as it is for professional traders. New traders may experience larger losing streaks as they’re learning, and professional traders aren’t necessarily immune to losing streaks either, so manage your risk properly so you have an account to trade when conditions are good and there are plenty of good setups to take.
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Robert Castillo – Currency & Commodities Trader,
Financial Analyst, Writer & Editor.
