If you are struggling to become a consistently profitable trader, then pause for a second, take a step back, and ask yourself if your trading strategy matches your personality.
How do you figure that out?
One of the steps in this process is figuring out your Trading Risk Tolerance Personality (TRTP). In this post, I'll explain what that is, why figuring it out is vital to your success in trading and how to figure it out.
What is Your Trading Risk Tolerance Personality?
The bottom line is that everyone has a certain level of risk that they are comfortable with. However, most traders don't take the time to figure out what that level of risk really is.
So your task is to figure out how much you are comfortable risking on each trade. This may seem like a simple thing, but it is immensely important to your success.
You may think that you should risk 10% or maybe even 20%, because you think that you can make 50%, or even 100% in profit. But the reality is that you shouldn't be risking more than 2% per trade.
Yes, you can still be consistently profitable, even when risking less than 1%. In fact, a lot of professional traders recommend it.
Risk Tolerance Can Make or Break a Trading System
You may think that a trading system is the only thing that will determine your success.
But there are so many more factors than that.
One example is the amount of risk that you take on one trade. The amount of risk that you take on each trade, can determine a few important things that you may not have thought about.
The Likelihood That You Will Take a Trade
If you take more risk than you are comfortable with, then you will be less likely to take a good trading opportunity.
It's like if you tried to start a campfire as a little kid and accidently burned your finger. You would probably be much less enthusiastic about helping build the campfire on the next camping trip.
Or if you invested in a rental property and lost a lot of money in the process. You would probably be turned off to the idea of real estate investing.
…essentially, you become gun shy and miss great opportunities.
You need to figure out a risk tolerance level that works for you. Otherwise, you will give up after a few losses.
How Much You Beat Yourself Up
When you lose more than you are comfortable losing on a trade, you will start to create a negative feedback loop that goes something like this:
- I lost and I don't feel comfortable with it
- I lost again and I feel even more uncomfortable
- I lost, how could I have been so stupid
- I lost, now I'm in trouble
- I lost, how could I have been so stupid
- I lost, that was a bad trade (even if it wasn't)
- …and so on…
Once that happens, you will begin to doubt every trade you make. So while there's no guarantee that using the right amount of risk per trade will solve this downward spiral (because other factors can contribute to it too), it can reduce the probability if it happening.
Sticking with a Trading System That Could Work
You may find a trading strategy that fits your personality perfectly. But if you risk too much per trade, then you lower the chances that it might work for you.
Even if the trader you learn it from says to risk X%, you can always risk whatever you feel comfortable with. That can help you stick with a system that you might have otherwise given up on.
How to Figure Our Your Risk Tolerance Personality
So how do you figure this out?
There are two ways that you can do this. First, you can open a demo account that is the same size as the real account that you are currently trading or you plan to open.
Then start taking trades with the following risk levels. Test each risk level for about 25 trades in a demo account and see how you feel.
- 0.25%
- 0.50%
- 1%
- 1.5%
- 2%
You don't even have to have a trading system. In fact, it's probably better that you lose more trades than you win.
Just take random trades and focus on what it would feel like to lose that amount of real money per trade.
It can be tough to properly simulate how it feels to lose real money, but do your best. This is the preferred way to figure out your risk tolerance.
Another way that you can do this is to put a very small amount of money in an account that allows you to trade nano lots. With nano lots, you can deposit as little as $100 and still take the risks listed above, on each trade.
Since you are trading real money, you should use a trading system and do your best to make money. But again, that should not be your primary goal.
You are trying to figure out which risk level is the best for you. For some traders, having real money on the line, no matter how small, is the only way to experience the true effect of a loss.
Only you can make the decision as to which method is best for you.
But What About Multiple Entries/Exits?
The great thing is that even when you are risking such a small amount of money, nano lots will allow you to split up your entries or exits. So you can still execute almost any trading strategy and simulate live trading conditions.
It can be hard to take the exact amount of risk when you are trading micro or mini lots. But nano lots make it possible.
…and mathematically speaking, you will make more money when you take the exact amount of risk on every trade.
Conclusion
Your risk tolerance might change over time, and that's OK. But in order to get off the Trading Silodrome and get closer to consistently profitable trading, you need to figure out what works best for you right now.
Focusing on nailing down a specific risk level that you are comfortable with is one of the three parts of the Trading Foundation. It is the groundwork of successful trading.
To learn the other two parts of the Foundation, read this.