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The Art of Risk Management

reading booksI’ve read many books about successful traders. ‘Market Wizards’ by Jack D Schwager is an obvious one. If you haven’t read it I’d suggest you get your hands on a copy.

One of the key lessons coming from many of the traders interviewed in the book, was to never risk more than 1% of your trading capital on any one trade.

New traders may misinterpret this as only being able to trade with 1% of your trading capital. Yet what it actually means is adjusting your stops and position sizing appropriately, so that your greatest loss is only 1%.

So if your trading capital is $100K, then only risking $1000 on each trade needs to be your goal. This way, when you are wrong, the consequences of a 1% loss are minimal. And you remain alive and well to trade another day.

It also decreases your stress levels. So you can maintain focus and continue to trade in the zone with your next position. Rather than being mentally distracted and tormented by your last loss.

And if you don’t understand the importance of risk management under this sort of framework, then you probably haven’t experienced the reality of having had 10 losses or more in a row.

If you haven’t experienced 10 losses or more in a row, then you likely haven’t been trading long enough.

Having more of a conscious focus on preserving capital than making money is important. Mainly due to the obvious fact that you can’t trade without money. And making money will happen if you can be disciplined in what you are doing and process driven. If you think that sounds a bit boring, it’s because it generally is.

Your trade entries are important, and need to be low risk via correct position sizing. It’s simple maths. The gap between your entry price and your stop position has to reflect 1% of your trading capital. If you can master this, you are likely going to be in this game for the long haul.

Then if you hit a sweet spot with your trade trigger and the trend takes off, your win loss ratio will start to increase exponentially. And all because you have applied a low risk trading strategy using the 1% rule.

Small losses are the secret to big wins.

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