Risk management rules
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Risk management in trading is surely one of the most important elements for success in the financial markets. Many novice traders neglect this aspect and reduce it to simply putting a stop loss on each position. Risk management is a set of rules that must be followed. Its rules are unique to each person, as is a trading strategy.
Managing risk means managing loss. This implies that we must accept losing. That's the first rule you have to follow. In trading, you can't always be right. Good analysis does not protect you from a losing trade. It doesn't matter if your scenario has a high probability of coming to fruition, in the end, it's the market that decides. You can't control the market, you just try to take the crumbs it wants to leave you. By starting from this observation, you’ll realize that it is impossible to avoid a multitude of losing trades throughout your trading life.
If you don't understand that, it's not even worth going any further in your reading. Accepting losses is the basis of trading. You can't win in the long run without accepting the loss. Once you understand this, you can think about risk management rules.
What counts in trading is to be a winner at the end of the month, regardless of the number of losing trades. Risk management is not just about looking good, it's what determines how much a losing trade costs you. If your winning trades bring you more than your losing trades take, it's because you manage your risk well, it's because you respect the risk management rules.
Novice traders often try to follow theoretical trading rules. These rules can be found on all specialized web sites offering training content. Following rules is essential to succeed in trading, but you must follow your own risk management rules!
Here are the main risk management rules in trading:
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It is important not to stop yourself from taking a position simply to respect this ratio. The only risk management rule to remember is that a losing trade should not cost you more than a winning trade.
After that, it all depends on your percentage of winning trades in your trading strategy. If you have a percentage higher than 50%, the simple fact of not taking a trade with a risk/return ratio lower than 1 is enough to make your strategy win at the end of the month.
If you have a low winning trades ratio (because you are looking to capture large trend movements), you need to increase your risk/return ratio for each trade.
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Some people place them above the last highest/lowest point, others try to reduce their risk as quickly as possible during the trade, still others work with trailing stops, etc.
There is no one method better than another. It all depends on your trading style. If you are looking to capture large movements, you are forced to operate with distanced stop losses. If you are trading shorter term (looking to capture small movements), it is better to try to reduce your risk quickly if the price allows it.
If you have too many losing trades, you should not distance your stop loss so that it is triggered less frequently, but rather try to improve the quality of your signals.
Losing a trade is no big deal. What is serious is that it costs you too much. The important thing is that your trading strategy can quickly catch up with a losing trade.
To determine the method that works best with your trading strategy, there is only one way, try it out! Test your strategy by leaving your stop loss fixed (determined at the start of the trade) then reducing your risk by quickly moving your stop loss (even if it means having a greater number of losing trades). In many cases, it is better to have more losing trades but lose less on each trade and secure your winnings quickly.
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This maximum loss level depends on each trader. It simply has to be a level that you feel able to cover quickly. For example, it can be double your average daily performance when you have a winning day.
If you allow yourself to go too high, it may be difficult to manage psychologically. And you know that when emotions come into play in your trading, it's the end! Losing 5% on a trading day is not tolerable. It's too hard to take. To catch up, you will want to increase your leverage and ultimately raze your trading account.
You should be aware that this threshold will serve you one day or another! It is therefore very important to define it in advance so as not to enter a negative spiral the day it happens to you. It's up to you to set your tolerance level for the maximum loss that you are able to take without flinching during a bad day’s trading.
Risk management is knowing how to manage your losses. These losses are part of trading, the sooner you accept it, the sooner you can work out the best way to manage your risk. A well-managed risk is often what makes the difference between a winning trader and a losing trader.
To properly manage your risk, you must follow very specific rules. There is not one but several possible risk management methods. The important thing is to find the risk management method best suited to your trading style, your psychology and your trading strategy.
At the end of each trade, if you have regrets, it is because you did not follow your trading rules. As Aristotle said: “Excellence is not an act but a habit.” Something to consider.
Risk management rules
Managing risk means managing loss. This implies that we must accept losing. That's the first rule you have to follow. In trading, you can't always be right. Good analysis does not protect you from a losing trade. It doesn't matter if your scenario has a high probability of coming to fruition, in the end, it's the market that decides. You can't control the market, you just try to take the crumbs it wants to leave you. By starting from this observation, you’ll realize that it is impossible to avoid a multitude of losing trades throughout your trading life.
If you don't understand that, it's not even worth going any further in your reading. Accepting losses is the basis of trading. You can't win in the long run without accepting the loss. Once you understand this, you can think about risk management rules.
What counts in trading is to be a winner at the end of the month, regardless of the number of losing trades. Risk management is not just about looking good, it's what determines how much a losing trade costs you. If your winning trades bring you more than your losing trades take, it's because you manage your risk well, it's because you respect the risk management rules.
Novice traders often try to follow theoretical trading rules. These rules can be found on all specialized web sites offering training content. Following rules is essential to succeed in trading, but you must follow your own risk management rules!
Your own risk management rules
Here are the main risk management rules in trading:
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Risk/return ratio
: Novice traders are generally advised to adhere to a gain / risk ratio of at least 2 on each position, in some cases this tends towards 3. A ratio of 3 means that one winning trade is enough to cover 3 losing trades. This is all theory.It is important not to stop yourself from taking a position simply to respect this ratio. The only risk management rule to remember is that a losing trade should not cost you more than a winning trade.
After that, it all depends on your percentage of winning trades in your trading strategy. If you have a percentage higher than 50%, the simple fact of not taking a trade with a risk/return ratio lower than 1 is enough to make your strategy win at the end of the month.
If you have a low winning trades ratio (because you are looking to capture large trend movements), you need to increase your risk/return ratio for each trade.
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Stop loss management
: This is the main tool for managing your trading risk. Stop loss management can be done in a thousand different ways depending on your trading strategy.Some people place them above the last highest/lowest point, others try to reduce their risk as quickly as possible during the trade, still others work with trailing stops, etc.
There is no one method better than another. It all depends on your trading style. If you are looking to capture large movements, you are forced to operate with distanced stop losses. If you are trading shorter term (looking to capture small movements), it is better to try to reduce your risk quickly if the price allows it.
If you have too many losing trades, you should not distance your stop loss so that it is triggered less frequently, but rather try to improve the quality of your signals.
Losing a trade is no big deal. What is serious is that it costs you too much. The important thing is that your trading strategy can quickly catch up with a losing trade.
To determine the method that works best with your trading strategy, there is only one way, try it out! Test your strategy by leaving your stop loss fixed (determined at the start of the trade) then reducing your risk by quickly moving your stop loss (even if it means having a greater number of losing trades). In many cases, it is better to have more losing trades but lose less on each trade and secure your winnings quickly.
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Maximum daily loss
: Every trader should have a maximum daily loss threshold. This is a very important element of risk management that can save you from razing your trading account! This is the threshold at which you stop trading. This therefore requires comprehensive risk management. For example, if you reach 2% loss during the day, you stop everything.This maximum loss level depends on each trader. It simply has to be a level that you feel able to cover quickly. For example, it can be double your average daily performance when you have a winning day.
If you allow yourself to go too high, it may be difficult to manage psychologically. And you know that when emotions come into play in your trading, it's the end! Losing 5% on a trading day is not tolerable. It's too hard to take. To catch up, you will want to increase your leverage and ultimately raze your trading account.
You should be aware that this threshold will serve you one day or another! It is therefore very important to define it in advance so as not to enter a negative spiral the day it happens to you. It's up to you to set your tolerance level for the maximum loss that you are able to take without flinching during a bad day’s trading.
Conclusion
Risk management is knowing how to manage your losses. These losses are part of trading, the sooner you accept it, the sooner you can work out the best way to manage your risk. A well-managed risk is often what makes the difference between a winning trader and a losing trader.
To properly manage your risk, you must follow very specific rules. There is not one but several possible risk management methods. The important thing is to find the risk management method best suited to your trading style, your psychology and your trading strategy.
At the end of each trade, if you have regrets, it is because you did not follow your trading rules. As Aristotle said: “Excellence is not an act but a habit.” Something to consider.
