If you’ve discovered or created a profitable Forex trading technique then congratulations. However, you have likely discovered that it takes more than a profitable trading technique to achieve consistent profitable trading results.
If you are new to trading, this may be a tough pill to swallow, but more experienced and profitable traders know that it takes more than knowing where to enter and exit a trade to become a consistently profitable trader.
An Overlooked Necessity
Oftentimes risk management is overlooked as traders search for a holy grail trading system that essentially minimizes or eliminates the need for good decision-making. However, every trader’s toolbox must contain a solid risk management plan if you want to join the small percentage of successful Forex traders.
In this post, I discuss my risk management strategy and tips that you can apply immediately to improve your trading results.
Trading as a Business
Professional traders treat their trading activity as a business. And as with any business, a certain amount of loss will be incurred. Be it in the form of damages, theft, lost items, or returns, it is inevitable that every business will encounter financial losses.
However, it is how a business owner handles losses that will impact their bottom line and ultimately determine if it is feasible to continue operating their business.
If you discovered that looters were planning to loot the stores on your street in the middle of the night, you wouldn’t choose to leave the door wide open and a lighted ‘OPEN’ sign to invite trouble. And you shouldn’t do this with your trading account either.
But, if you put on a trade without calculating the risk and what you plan to do f the trade goes against you then that is essentially what you are doing — leaving your account wide open and available for others to take all of your funds.
Risk Tolerance and Acceptance
As Mark Douglas discusses in Trading in the Zone simply putting on a trade and accepting the possibility of it being a loser are not one in the same.
- The first step in managing your trading risk is to determine what percentage of your capital you are willing to lose if the trade does not go in your favor
- The next step is to accept that if your stop loss is hit that any loss incurred is just a cost of doing business. Brush it off. Manage your other trades. And look for the next trade setup.
Calculating Your Risk
It is commonly recommended among traders to limit your risk exposure to 1-2%. Although that is a good rule of thumb one should also take into consideration the following:
The more that your winners outperform your losers the higher the risk that you can tolerate. In contrast, if your win/loss ratio is low then you want to keep your risk exposure to less than 1% or stay on a demo account until your win/loss ratio is 50/50 or better.
Another consideration is your overall level of comfort and tolerance for risk. Are you uneasy with uncertainty? How do you cope with obstacles? Does losses upset you?
One of my trading rules is to not allow trading losses to adversely impact my mood. And in general, I don’t like to lose in one day, more than what I can earn during an average day. This keeps me level headed, so that is is easier not to revenge trade.
For my primary trading account, I risk 1% per position for an overall risk exposure of 5-10%, but I will occasionally go up to a max of a 20% risk.
For a $100,000 account that’s a risk of $1,000 per position for a total risk exposure of $10,000 for 10 active positions.
My risk tolerance for my secondary accounts may be more or less depending on my goals for those accounts.
For many traders, reaching a point where they can move their stop loss to break even and let the remainder of their trade ride risk free is the ultimate in trade management. And that is a good approach for balancing capital preservation and growth.
However, I take a slightly different approach as I place a strong emphasis on account growth.
As price progresses in my direction, I use my pyramiding strategy to add to my position size while moving in my stop loss and closing a portion of my added positions to keep my risk exposure to 1% or less per position.
I have had tremendous success with this strategy as it allows me to preserve my capital while also multiplying my account in a short period of time.
You probably noticed that I mentioned limiting my risk per position to 1%, but my overall risk to 5-10%. This is because I usually trade 5-10 pairs concurrently. This has many benefits.
- Increases my odds of being in winning trades and ending each week in profit
- Increases my overall profits as limiting myself to trading one pair could mean that I am missing out on a pair that is making significant moves in price while trading a pair that is consolidating
- Eliminates the stress caused by losses. If 1 or 2 trades are losers, and 8 or 9 are winners then I win in the end
Slow and Steady
Although it is tempting to trade as much of your capital as possible this is also why traders find themselves repeatedly blowing their trading accounts.
If you gain 2% per day after 5 days you would have added 10% to your trading account That’s a great profit and doable especially if you swing trade or trade the larger time frames.
I would love to hear from you. How much do you risk per trade and what is your overall risk tolerance for all active trades?