One of the phrases that you have probably heard the most since starting out with trading is risk management, but what does that actually mean, and do you do it? To put it into simple terms, risk management is about reducing the potential risks to your account and protecting your account from dangers and large losses. This sounds simple enough and quite an obvious thing, but you will be surprised at how many people throw it out of the window on their quest for bigger profits.
Risk a Set Amount
One way that people reduce the amount of risk that they have on each trade is to limit the potential losses of each trade, they do this by setting stop losses on each trade that they make. A number that we see a lot of 2%, people seem willing to risk 2% of their overall account on each trade that they make, this would mean that the account would be able to survive up to 50 losing trades on a row without any wins, something that is very unlikely if a proper strategy is being implemented properly. It is important that if you set yourself a maximum loss per trade that you stick with it or if you deviate, only to deviate lower, going higher will put your strategy out of sync and could potentially damage your account equity quite a bit.
Adding to Trades
Something that a lot of people do is to add positions to an already winning trade. This basically means that when a trade is going the right way, you add in an additional trade to make the overall trade size a little larger. While this may work for some, a lot of strategies have not taken this into account so you should be careful when considering it. When you do add an additional trade, you need to bear in mind that your overall risk is increasing, do you stick to a maximum 2% loss on that trade, or do you increase or reduce it? Unless your strategy has already taken these additional trades into consideration we would advise against adding to existing trades as it could mean you can lose more than you had anticipated on that trade.
The Right Trade Size
How are you working out your trade sizes? Is it based on your account size or your strategy? Whichever method of working it out that you use, you need to stick with it. More often than not, your trade size would be based on the percentage of the account you are willing to risk with each trade. There are trade size calculators available all over the web that can help you to work out the exact size of each trade that you should be using based on the pair being traded and the percentage of the account that you are willing to risk. It is important to stick to regular and similar trade sizes for each trade, as suddenly adding larger trades could completely throw your risk management out the window and could be endangering more of your account equity than you would normally be willing to risk.
Something that people often don’t associate with risks is taking profits, knowing when to come out of trades is just as important to protect your account as restricting your losses. To put this into perspective, a trade has gone into profits, you feel that it may reverse but it is in profit so you will let it run to see if it goes any higher, it suddenly reverses and you are now back to a break-even level or even in the negatives. In order to protect your account, it should have been taken in profit, many people use take profit levels, others have a certain percentage where they move the stop loss levels into profits to guarantee the profits. The importance of doing this is that you will have wins and losses, but it is important that you are able to take those wins as they are there to help cancel out the losses, having them also become losses will put your account in danger.
So those are a few things to think about when looking at the risks you have to your account, there are of course many other things to think about, but those are some of the bigger ones. Think about whether you do these things, if you do, think about how you can improve on your own risk management for the future to help protect your account.