Money Management

In trading, there is no such thing as being right all the time. There will be times when your trade will not follow your analysis no matter how well you think through it. Each trade that you place carries a risk to it and you must be aware of the amount of risk that is associated with that trade.

Learning how to manage risk is one of the most important concepts in trading and it is something you should not neglect. Having proper risk management is what separates successful traders from the rest.

To manage risk, you must determine the risk to reward ratio of every trade that you place. This ratio indicates how much you are risking compared to the potential profit. You must also calculate the lot size which you are allowed to use. Placing a lot size that is too big can blow your account in an instant. You should also know the maximum risk you wish to have. Risking a small percentage of your account can help you trade smoothly and avoid taking huge losses.

How To Determine The Risk?

To determine the risk, calculate your current balance. Then multiply it by the risk percent you wish to have. The result will be the total amount of money you are willing to lose for each trade.

We recommend that you risk no more than 5% of your total balance.

The next step is to look at your current setup’s stop loss size. This will help you determine the lot size you should be placing.

The formula for calculating your risk and determining your lot size:

Balance x Percent_Risk = Max_Loss
(Max_Loss / Stop_Loss_Pips) x (1/10) = Lot Size

For example:

If you have a starting balance of $1000, and you have a 5% risk, your maximum loss/drawdown should be $50 out of the $1000.

Next, calculate the risk-reward for your trade. A minimum is a 1:1 risk-reward. A 1:2 risk-reward is good. A 1:3 risk-reward is great. It means that your potential profit is triple your potential loss.So if you happen to find a setup that has a take-profit target of 150 pips. With a 1:3 risk-reward, your stop-loss will be 150 pips / 3 which will result in 50 pips.

Calculating our max potential loss : $1000 x 0.05 = $50

Calculating our max lot size : ( 50 / 50 ) x ( 1 / 10 ) = 0.10 Lot Size

This means that 0.10 Lot Size will be your max lot size in total. If you plan to place multiple positions in this trade, you can split the lot sizes. So if you wanted to have two positions, you can have a 0.05 Lot and a 0.05 Lot, but it all adds up to the max lot size which is 0.10.

Which Risk-Reward Ratio Should I Use?

For every trade you place, your minimum risk-reward ratio should be at least 1:1. However, the bigger your target is compared to your stop loss, the better. So having a 1:2 or a 1:3 risk-reward is much preferable. However, it all depends on the market condition and the type of setup that you have.

If your target is bigger than your stop loss, overtime you will become profitable. So with a 1:2 risk-reward, for every loss you take, your profit will be twice as big. 

When you have a good risk-reward ratio and proper risk, you will less likely blow your account and more likely be profitable in the long run. It can take some time to find setups that have a great risk-reward ratio, but the patience will payoff. 

Stop Loss Placement

Knowing that you cannot always win all your trades, having a stop loss will help you minimize those risks associated with the losing trades.

A good rule to have is to always have a stop loss no matter how confident you are in the trade because the market can turn against you at any time, sometimes in a rapid motion.

Your stop loss should be determined before you even place your trade. It is there to protect your risk so you should always take time to place it where it is reasonable and not based on emotions.

Not every trade will be profitable instantly the moment you place it, so do not panic when you see the market go against you. The market will not always move in a straight direction. Sometimes it will be in a consolidation for a period of time. It is important to let your trades breathe and allow them to be able to fluctuate before going to your target.

Trading with proper risk management is what will separate successful trader from the rest. It is just as important as technical analysis yet it is something that a lot of trader overlook.

Trading is all about consistency, and if you have consistent proper risk management, you will be profitable in the long run.

When looking for setups, you want to take this into account. Set a rule of only looking for setups that has at least 1:1 risk-reward or a 1:2 or a 1:3. By having this rule, you will only be looking for setups that will make you profitable in the long run.

Apply this to your trading today and see how well it will work for you.