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Most risk management tutorials simply tell you risk 1% per trade and that's all you need.
That's certainly a decent starting point, but it's only a very small part of a true Risk Management Plan.
In this lesson, I'll go over what you should take into account when managing your trading risk.
Trading Psychology Risk
The first point to consider when creating your Risk Management Plan is how much your risk per trade will affect your psychology.
Risking 1% per trade can be too much for some traders.
One way to figure out if you are risking too much is to reflect on how you feel after a loss. Write this in your journal. Is it no big deal, or are you devastated?
If the loss is hard to handle emotionally, it will negatively impact your ability to take trades in the future. Obviously, you can only make your money back if you're willing to take more trades.
So you should start by only risking an amount that's comfortable for you. If 1% is too much, then drop it down to 0.5% or less. Be willing to experiment with different risk levels until you are totally comfortable with taking trades.
On the other hand, if you think you can handle more risk, consider bumping it up to between 1% and 2% per trade. I wouldn't suggest risking more than that when you are first starting out.
But you may be able to increase it later as you test and get more data.
Maximum Drawdown Risk
The amount you risk will also depend on your trading strategy. What's your win rate and average profit per trade?
These metrics will determine how much you can comfortably risk per trade, without blowing out your account.
You won't have that information when you are first starting out. But once you go through the steps in this course, you can plug your numbers into this calculator and it will give you how much you should risk to avoid a “freak out” level drawdown.
Another area to examine is your total portfolio risk.
Simply put, what's the maximum that you are willing to lose if all of your open trades hit their stop losses?
This will limit the number of trades that you can take at one time.
It can be helpful to set a maximum allowable risk per day, week or month. Not all traders will benefit from doing this, but it's an option to consider.
Are there events going on in the world that's causing the market to have large, erratic moves?
If so, then you might want to dial back your risk per trade and potentially widen your stop losses.
Continuing to trade like you normally do can lead to big losses.
Finally, ask yourself how you'll manage trading 2 or more currency pairs that have a similar signal and a common currency.
For example, what will you do if you see that the EURUSD and EURCAD are forming similar chart patterns?
There are a few different options here:
- Take only the best looking trade out of the bunch
- Take all trades at full size
- Take all trades at a reduced size
I just want to introduce you to a few ideas on risk management, so you know where to begin and have an idea of what to look out for in the future. When you are starting out, risk 1% or less per trade.
But as you start getting more data and refining your skills, don't feel that you're locked into that risk profile. Also examine the other factors that are mentioned in this lesson and adjust accordingly.
Risk management is an important topic, so come back to this lesson as much as you need to. Let's move on to the next lesson…