Manage Risk

Manage Risk

No matter how carefully you plan to manage your losses and profits, trading is inherently risky. There is no way around this fact, but you can protect yourself from the worst aspects of risk, if you are aware of the ways to do so.

Another rule that you should always follow is to never add to a losing trade. If a trade has started moving against you, adding to your position on that trade will be extremely risky. The likelihood of it suddenly turning around and becoming profitable is very slim. If you are convinced there is potential for profit in the position, wait until it shows some profit before adding to it.

If you do wait until a position has shown a profit before adding to it, you will soon notice that nearly every losing trade ends up hitting your stop loss and does not change direction. Sometimes the trade does turn around before it hits your stop and becomes a winner. You can consider yourself very lucky if that happens.

But sometimes the trade hits your stop loss and then turns around and becomes a winner and you’ve guessed wrong. However, this is even more rare. But whatever happens, it is never worth adding to a losing position, hoping that it will eventually be a winner. The odds of success are just too low to risk more capital on top of your initial risk.

You should also never risk too much capital on a single trade. You can’t trade without capital, so if you lose all your capital you are out of the game indefinitely. In poker, they say that going all-in works every time but once. It is the same in trading. If you risk all of your account on every trade it only takes one loss to wipe you out. You will be out of the game at some point, it’s only a matter of when

In general, you should only risk 1-3% of your available capital on any individual trade. This percentage is calculated using the size of the position, the difference between your entry price and your maximum stop price, and your amount of capital. All trades that you make should seem almost inconsequential to your capital. If you are worried about the size of a trade it is too big, and you should reduce your position immediately.

Remember that the longer you stay trading the more money you’ll make. Trading slowly over a long time with minimal risk is always preferable to rapidly with too much risk. Also consider the risk of each trade. Your system should have a way of calculating the potential risk and reward of each trade.

If your system is set up so that you trade only when the upside outweighs the downside of the trade, your profits will be defined by the number of trades you make, how much capital you have to work with and how well you read your trading signals.

A trading system like this is called a Positive Expectancy system. Expectancy is calculated using the profit or loss on each trade; divided by the initial risk, and then taking the average overf a series of trades. Systems that have positive expectancy will make money most of the time and those with negative expectancy will lose money.

Trading is about taking a reasonable amount of risk in order to achieve a good reward. You can’t control the markets, and you can’t eliminate risk entirely. Which is why you should never trade if you need your capital to pay bills. Do not trade if your business and personal expenses are not covered by another income stream or a cash reserve. Being required to make a certain amount of dollars per month to live is the best way I know to completely mess up all trading discipline, rules, objectives, and leads to disaster.

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