In this article I will help you understand how to manage risk when trading the financial markets. I will share what I do to manage risk, in my personal trading, to achieve a 60% win rate with a 1.5:1 reward/risk ratio. Managing risk is possibly the most important part of learning how to trade. You will require extreme levels of discipline. Without successful risk management you will not be profitable. I hope you enojoy this article and you find it helpful.
What does it mean to manage risk?
To manage risk means you are controlling your losses in such a way that your trading style is sustainable. If you place 100% of your capital balance on one trade and it goes against you with no stop loss, this is clearly not sustainable. This is an extreme illustration but the successful traders will have a plan in place of what they consider to be the sweet spot in terms of the amount they risk on each trade versus their overall capital balance, taking into account the win rate and reward/risk ratio they are achieving.
Illustration of how you might be able to manage risk in your trading
Lets say you have an account balance of £10,000. The best advice I can give is for you to divide this balance by 100 and only risk £100 on each trade position and to keep this strictly consistent. Why? Because there are times when you may end up with a few losses in a row, and such a small amount out of your capital balance will not be felt by you and will not end up causing you to be discouraged. When you are trading, you want your emotions to feel calm and controlled. If you are only risking 1% of your capital balance, your emotions will not get into the way of decision making (to either close a trade or take a profit for example). Also you need this to be consistent so that your win rate makes sense. If you make 1.5 x your risk on profitable trades, you don’t want this to be erratic in terms of the amount risked. It is better for you to always make £100 loss on losing trades and then £150 profit on wining trades.
Practical examples – how to manage risk
So lets say, you follow my advice and only risk £100 per trade… you will want to cut your losses on trades which are going against you, at the value of £100. How can you control the trade in this way?
If you are trading with a margin account…
If you are trading with a margin account, you would control the ‘position size’ such that the loss ends up being £100 at a certain level. Let’s look at a practical example:
I use Trading View to look at charts and execute orders. In the above screen print, you can see a limit order ticket. You can also see a similar ticket on a ‘buy’ order. Take a look, also, at the red and green rectangular shapes I have added to the chart. These shapes indicate the entry point, loss point and profit target of a trade with a 1.5:1 reward risk ratio.
You can see in the ‘units’ box of the buy ticket, that I have controlled the number of units being purchased in the market to end up with a £100 loss in the stop loss column. The profit is set to £150.
This is literally how I execute my trades every time I enter the market.
If you are trading by purchasing actual stocks without margin
If you are not trading with a margin account, you can control your position size in a similar way to achieve the same result of ‘restricting’ your loss to £100 per trade. Lets say you want to get into the same market in a normal share purchase account (Google Class C). You can open one of these accounts with Etoro as an example. I do not have any affiliation with Etoro (just for your info). The entry price per Etoro currently is $156.07. The difference between the margin trading price and the Etoro share purchase price is the spread – this is explained in a separate article but you need not worry about it here if you are not using margin. Lets say the stop loss level on your chart is at a price of $148.67 (taken from the same chart screen shot above – the price level at the bottom of the ‘red zone’). (To understand where to set your stop loss level please see our other blog articles on creating a trading plan and managing risk. The placement of the stop in the screen shot is not in any way indicative of where you should place your stop generally – this discussion is just to illustrate the calculations of restricting your loss). Let’s also say you will take your profit when the price reaches $164.64 (taken from the top of the green zone on the chart picture above – again, there will be a ‘spread’ difference on price here).
Now, in order to control the value of your loss, you would need to calculate how many shares to buy in this market based on the stop loss price level. I have provided you with a simple calculation to achieve this when not using a margin account:
Please note the FX rate used is just a rough guide – it is not accurate.
So if you want to risk £100 per trade on this Google market, you would need to purchase 16.22 shares. If you want to risk £15 per trade, you would need to purchase 2.43 shares.
When restricting your losses to the same amount each time, you can control your risk. Your trading will feel comfortable and under control. You are unlikely to make more than about 4 or 5 losses in a row so your account could dip by £500 at any one time, when risking £100 per trade (out of a total balance of £10,000 (10,000/100 = £100)) or your account could dip by £75 when risking £15 per trade, and your total account size is £1,500.
How many entries on the market should you open at once?
For me, I restrict this to 3… but really I aim for one. The reason I have three open at once sometimes is because I am running some ‘funds’ within my capital / trading to either accumulate or pay for certain things within my lifestyle. This is the reason you will see me close three positions of the exact same market and size sometimes within my Patreon live trading demonstrations. However, the rule is generally to have one open at a time.
In applying this risk management, and with the correct trading strategy (please see my Patreon page to learn how to achieve a 60% win rate with a 1.5:1 reward risk ratio here:
https://www.patreon.com/Traderpro8320
you can control your risk and watch your profits and account size slowly grow.
I hope you enjoyed this article.
For more great tips and advice on trading the stock market, please visit:
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https://www.patreon.com/Traderpro8320
Finally, if you would like to receive a discount on the Trading View charting software I use, please click on the relevant link here:
https://www.tradingview.com/?aff_id=117138
Please note any subscriptions taken via my affiliate link with Trading View may result in me earning a small commission. However, I provide complete transparency on me using Trading View personally – I publish my success on the financial markets via my broker reports and any profits earned were done so by using my own Trading View subscription, so I genuinely do recommend them and have been using the Trading View charts for many years