RISK MANAGEMENT
Risk management needs to be structured and strict at all times.
There will always be some sort of risk but you need to manage that risk according to your experience and the size of your account.
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So when trading you shouldn’t ever risk more than 1-3% of your total capital on one particular trade. You have to remember that however confident you are in a setup, anything can happen in the market at any time. You can never possibly know when the big players will jump into the market and significantly affect your trade. It’s important to stick to this percentage of risk, which is primarily for swing trading. Some scalpers use even smaller percentages because it’s a lot more volatile.
In the picture above you can see profits from one of my trading friends for 22.5k, a trade which lasted approximately 2 weeks.
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You can see from the figures that he risked 13 dollars a pip for a reward of 22.5k in total.
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This trade was made risk free after the first day because he moved his stop loss past breakeven and into profit. Remember trading is about making money and protecting your capital.
Alongside this percentage rule you also need to have rules set for minimum Risk to Reward. What we mean by this is how much you’re planning on risking compared to how much you will gain from the trade.
The minimum risk to reward ratio you should ever consider is 1:1 but even this is not something we recommend. A 1:1 risk reward ratio trade would consist of you risking 1% to make 1% on your account.
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A good risk to reward ratio would be a 1:3 ratio, so say you risk 1%, to make 3%. This kind of risk reward ratios are what we like to use.
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Not only for the obvious reason that you will be making more money off your investment, but if you lost three trades at 1:3 risk reward ratio and won one at the same 1:3 ratio, you’re back to your initial 3% despite the fact that you’ve lost three trades and won one. That’s how you create longevity in your trading, stick to your rules.
If you ignore the trade setups themselves but focus on the risk reward ratios, here are some examples of acceptable risk reward ratios
The risk reward tool is very helpful to work out whether a trade is worth taking or not.
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These two examples are the minimum risk reward requirements.
If the trade setup looks great but the risk reward ratio looks bad then don't take the trade. Your trading strategy is there to protect your capital, not just grow it.
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This is an example of a great risk reward ratio, alongside technical analysis building a high probability trade.
The best way to work out the risk reward ratio is to use the tool which you find on most charting software (we use www.tradingview.com), if not, work out the amount of pips you need in your stop loss and then from there you can calculate what the minimum risk reward is for the trade.
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In the example above you can see a strong 1:3 risk reward setup, these are the kind of setups you need to be looking for, the better the risk reward ratio, the more profitable you will be in the long run.
As a general rule you need to stick by is this:
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Risk amount in £/$ divided by stoploss size( amount of pips from current price to stop loss) = correct lot size to use
We’ll say it again: Risk amount in £/$ divided by stoploss size = correct lot size to use
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What we mean by this is if you have a £1,000 account and you want to risk 2%, that would mean your risk amount is £20. Now we divide that by our stoploss (in this example it’s 20 pips) this would mean the correct lot size you should use is £1 a pip.
Here is another example:
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You have a £5,000 account and you want to risk 3% on this trade at a risk reward ratio of 1:3. You would be risking £150 to make £450. If you take your risk amount of £150 and divide by your stop loss, which in this case is 60 pips, that would mean your correct lot size to trade with is £3.75 a pip.
The majority of traders lose but this is not because they are losing more trades than they are winning. It’s because their losses are bigger than their winners. Sticking to good risk reward trades and religiously keeping to 1-3% risk per trade will ensure that your losses are never bigger than your profits.
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Ensuring you work out your risk reward ratios before trading, helps you realise whether it’s worth it or not. Even if the trade looks perfect but the risk to reward is out, it’s better to sit on your hands and look for the next opportunity.
