One of the biggest questions that any trader faces is “how much should I risk on each trade?” Well, the answer to this question isn’t so simple. There is no “fixed dollar risk amount” that all traders adhere to. In fact, to truly answer this question, you will need to factor in your trading account balance, strategy, and risk tolerance.
Read on to learn more about per trade risk management and how you can make the most out of your trading capital.
As active traders, it’s important that we are always cognizant of risk. It’s crucial to evaluate risk on an ongoing basis, either by the trade, session, week, month, or year. Unfortunately, many traders ignore this duty; and guess what? Many traders lose.
For active traders, one of the best ways of managing risk is on a per-trade basis. While it’s important to view profitability within the context of longer time frames, it’s also crucial to respect the risk posed by each and every trade. So, how can we do that? By ensuring that a single trade doesn’t place the trading account in any undue danger. In other words, don’t bet it all on one roll of the dice!
A good per trade risk management plan clearly defines the following:
From a practical standpoint, the forex market is a dynamic atmosphere with countless possibilities. Therefore, each and every forex trader has a multitude of potential profit and loss outcomes.
In reality, you may make a lot of money, lose a lot of money, or hover near break-even with your trades. However, there is one thing for certain — without some type of risk management in place, your trading capital is in jeopardy!
Money management is the process of monitoring the impact of financial transactions. This means many different things, as individuals, corporations, banks, and even governments actively manage their finances. If they don’t, then insolvency and bankruptcy aren’t too far away!
Regardless of whether one is investing, swing trading, or day trading currencies, money management is the study of capital inflows and outflows. Money comes in when you succeed and out when you fail; that’s all there is to it.
The primary goal of forex money management is to maximize the potential of your trading capital. To do so, it aligns risk to reward and makes sure that no one trade can blow out the trading account. Contrary to risk management, money management puts a hard dollar value on the risk assumed during each trade, session, week, month, or year.
For active forex traders, money management is the implementation of rules designed to preserve and grow the trading account. These rules are typically applied on a per-trade basis via the parameters listed below:
One of the great things about forex trading is that there are no concrete rules. The “right” way to trade is one that makes money! Nonetheless, to be consistently profitable, it’s imperative that you aggressively manage your money and make sure that no one trade sinks your entire operation.
Now that we know a bit about per trade risk management and money management, we can talk about how much to risk per trade. Once again, there’s no clear-cut answer to this question. The most popular answer is to try to limit your risk to 2% per trade. But, even that might be a little high for newbie forex traders.
Let’s defer to the hard statistics. Take a quick look at this table that shows the difference between risking 2% of your capital per trade compared to risking 10% percent. The stats don’t lie; the greater your risk appetite, the greater your chance of going bust!
It’s clear to see that there’s a HUGE difference between risking 2% vs risking 10% of your capital on just a single trade. Remember, it really doesn’t matter if you are scalping, day trading, or investing for the long haul — the more you risk, the greater your exposure. Take our word for it, many forex day traders have learned this lesson the hard way!
When it comes to money, sometimes looking at a real-world scenario helps. Imagine that you hit a losing streak day trading and lost 15 trades in a row, risking 10% on each trade. If your starting balance was $20,000, then you would only be left with $4,575. That’s over 85% of your account gone. Boom. Just like that.
On the other hand, assume that you only risked 2% on each trade. While the damage is still severe, you’d have only lost 30% of your total account and you would still have $13,903 in your pocket. Although you’re down nearly half of your cash, there’s still time to study the actual trading results. Perhaps adjust your trading rules? Fine-tune your stop loss locations? Adjust your position sizes?
The consecutive-run-of-losers scenario is an ominous one. The truth is, you guys don’t even want to think about losing 15 trades in a row. You probably believe such a bad run is impossible or at the very least a Black Swan.
Well, these things happen, just ask the forex day traders that worked for Long Term Capital Management (LTCM) in the 1990s. After being consistently profitable for years, the bottom fell out and the firm lost billions. Ultimately, LTCM’s risk per trade was way too high and a bad run cost upwards of US$4 billion.
Ok, so it’s improbable that you will lose 15 trades in a row; we’ll concede that. Nonetheless, the difference would still be significant even if you had only lost 5 trades in a row. And, losing 5 in a row isn’t uncommon when scalping or day trading. In fact, it happens more than you would like to think; that’s why most pros put a stop loss on each and every trade!
When you implement your trading strategies, it’s crucial that you set up your risk management rules in a way that when you hit a rough patch, you will still have enough $$$ to stay in the game. This means actively addressing your risk per trade and implementing stop-loss orders.
Can you imagine losing 80% of your account balance?!! You would have to make a 400% profit of your remaining balance to just break even. 400%!!!!!!!!!
In the table below, we’ll look at a number of different examples that show how much you’d have to make to break even if you were to lose a certain % of your account balance. The truth is right there in black and white. The more you lose, the harder it is to get back your starting capital.
There’s no doubt about it, money and risk management are critical aspects of a successful trade. It doesn’t matter if you’re taking a long or short trade using a tight or baggy stop loss — you must apply trade-based rules that address risk. A great way to do this is by adopting a per trade risk management philosophy.
We can’t stress this enough: PROTECT YOUR TRADING ACCOUNT.
It’s an old saying, but it’s true: you are your own best stop loss! Only you are responsible for how much money you lose on a given trade — only you. That’s why understanding how to protect your trading account is key to growing your total capital.
From the first trade of the day to the last, you must always keep risk in check. If not, an unfortunate run of losing trade setups can spell doom for even the strongest strategy. Don’t fall victim to bad luck; adopt an approach to the market that will help you survive the worst-case scenario.
At the end of the day, successful traders are always mindful of their account balance and assumed risk per trade. These are critical factors that drive sustainability in the marketplace. If you’re not in-tune with your risk, get on top of the situation immediately.
Remember, only risk a small percentage of your account balance on any one trade. That way, the world won’t come crashing down when you hit a losing streak!
You got this! On to the next lesson!
Mimic how professionals trade. Discover your inner talent. Learn everything you need to know about trading the markets from beginner level to the most advanced, helping you to create critical skills and techniques to you can apply in your trading right away.
Mimic how professionals trade. Discover your inner talent.
Learn everything you need to know about trading the markets from beginner level to the most advanced, helping you to create critical skills and techniques to you can apply in your trading right away.
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