Trading Risk Management

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Besides being able to determine good entry points for your trades, trading risk management is the single most important aspect of profitable online forex trading.

If you do not have excellent trading risk management it’s unlikely that you’re going to make money in the long run as a forex trader.

You see, the main reason why the majority of forex traders blow their accounts is because they simply do not have good trading risk management. No matter how good a trader you are, you will make losing trades. It doesn’t matter if you’ve been trading for 20 years or you have a phd in finance, no single person is able to make correct calls for profitable trades 100% of the time.

Where most traders go wrong is thinking that they don’t need trading risk management. Sometimes consecutive winning trades trick you into thinking that you’re the greatest trader in the world and that you simply can’t make mistakes. But even if you get 9 out of 10 trades correct and make a profit from them, that 1 wrong trade can cause you to lose everything you made in those 9 winning trades and more.

In order to prevent you from losing significant money on a single wrong trade you need to have strict trading risk management.

What Is Trading Risk Management?

Trading risk management is the strategy you follow to manage the downside risk of every trade you make.

The nature of forex trading is that there is always a risk involved. As soon as you enter a trade there is the possibility that the trade will go against you and that you will lose money. Sometimes this drawdown is minimal and will reverse to turn into a profit, but there are also times when the market will keep moving against you so much that it will cause substantial loss if you continue to hold that position.

This is why it’s necessary to have trading risk management so that in the event of the market moving against you, you will only lose an amount that will not cripple your account. This is done through setting a stop loss as soon as you enter a trade that will limit your risk to an amount your account is comfortable with (I recommend risking no more than 5% of your account on a single trade).

My Trading Risk Management Strategy

As I’ve already mentioned, there are two aspects to profitable forex trading. The first is to be able to determine profitable entry points and be right at least 60% of the time with your trades.. The second aspect is good trading risk management to prevent you from losing more than you win in the 40% or less that your trades are losing trades.

You can be the best analyst in the world and come up with 90% winning trades, but without the risk management, those 10% losing trades could ruin you and blow your entire account.

My trading risk management strategy is the following:

1- Risk no more than 5% of your account on a single trade, but preferably keep that risk around the 2% level.

2- Place your stop-loss (according to the above risk level) as soon as you enter a trade to eliminate the possibility of the emotions of fear or greed that could cloud your judgement. Every trade is purely mechanical. It’s either right and you’ll make a profit, or it’s wrong and you’ll lose a per-determined amount that doesn’t pose a severe threat to your account.

3- The third part of my trading risk management strategy is to manage your risk as soon as your trade starts to become profitable. There’s nothing more annoying than when a profitable trade turns into a losing trade. How exactly you do this depends on your trading style and the time-frames on which you trade.

For example, I like to trade on 4 hour and daily time-frames, meaning that my trades have the potential to move hundreds of pips. When my trade becomes profitable, I like to move my stop loss up to 100 or even 50 pips below the current price action, meaning that as soon as my trade gets in a profit of 50 pips, I’ll move my stop up to break-even to eliminate any risk from the trade. In that case, at worst I’ll get stopped out with no loss and at best I keep moving my stop up as the price action rises and make a nice profit.

FILED UNDER: TRADING RISK MANAGEMENT