The trader who manages his or her risk well is 10x more likely to become successful compared to the trader who focuses only on strategy.
It is not that strategy isn’t important, however, time and time again most traders forget that trading isn’t exactly a science.
Trading is an art, one that gives different results depending on the season, time, and several other factors.
What this means is that, there is no 100% successful strategy, forget about all those scams telling you they could give you a 100% profitable strategy, it just doesn’t exist under God’s given sun.
If there is no foolproof strategy, what then can one do? well understand that there is no foolproof strategy, and your chances of winning any single trade can be likened to the toss of a coin.
If I ask you to bet your life savings on a single coin toss, would you play that game? I guess not, I wouldn’t either, that would be the definition of insanity.
However, that is what most traders do, risking their entire trading account because a trade went rogue.
Expanding their stop losses, or removing it altogether, underestimating the length to which the market can go, all in the hopes that it might come back so you break even is a very bad move.
Not only are you hurting yourself emotionally, but you also tie up funds that could have taken other positions to bring you much needed money.
Risk Management in Forex
If I ask you to bet $100 for $50, would you play such a game? I guess not, I wouldn’t either.
How about I ask you to bet $100 for $200 or even $300 or more? I would play that game, knowing that even if I lose half of the time, I still stand a chance of making profits.
This is the idea from which risk and reward ratios were derived from. Risking less than you expect to gain is a viable strategy.
- For every trade that you take, ensure that your risk to reward ratio is at the very least 1:2 otherwise, ignore the trade.
Now, the general consensus out there when it comes to risk to reward is that you should be risking for example 100 pips for 200 pips.
Experience has shown that you could still lose a lot of money following that approach if you don’t consider the absolute value of the money involved.
You risk 100 pips for 200 pips profits with 1 lot size per trade, but the value of a pip indeed differs, when in doubt, refer to our earlier lesson on that.
Many make this mistake, and before long, they lose a 100 pip which is worth far more than $100 even though they used 1 lot size.
Pairs like GBPJPY have far more pip value compared to other pairs, we can talk about XAG USD and XAU USD, which have even far greater pip values.
One 100 pip loss in XAG USD can indeed blow your account if you aren’t careful.
So what’s the way out?
Use absolute values only, determine for yourself how much in dollar terms you are actually willing to lose or gain per trade.
If you are willing to lose $50 per trade or $100 per trade, then regardless of the pips involved, you work out the correct lot size to use per trade.
What is going to happen here is that you may have very different lot sizes in your account history, depending on the pips value and number of pips you are accounting for, but your account would see and observe continuous growth, so much growth than you could ever imagine.
With this, even if you lose half of your trades, you would still be able to make money, that is why trading is the simplest and most profitable business there is.
You don’t need to be a genius to make money here, you just need to be able to manage your risks.
What factors to consider when determining how much to risk per trade;
If you follow the absolute value risk-reward strategy, know this, from probability theorem, the big number theory states that you get closer and closer to the expected value, with larger sample size.
Therefore, if we say a strategy has a 50% chance of winning, that 50% rate, only happens when you take a high number of trades.
which means, you need to give yourself enough chances at success. To do this, never risk more than 1% of your trading capital.
Now this can be controversial, people who follow that advice point blunk often increase their risk when they are winning and reduces their risk while losing, this means while you are losing, you have to work even extra harder to recover your losses.
That is a bad strategy. Here is what works.
- Each month, determine your trading capital.
- Take 1% of the trading capital
- The absolute value of the 1% you get, is how much you should risk per trade for the entire month, whether win or lose.
- This gives you 100 trades in total for the month, I can almost guarantee your success if you follow this approach.
After the end of the month, evaluate your account size, and go over the process again.
That my friends is how you manage risk