Risk management is one of the most important topics you will ever read about trading!
What is risk management?
These are individual actions that allow traders to protect themselves from the downside of a trade. More risk means a greater likelihood of significant gains, but also a greater likelihood of significant losses. Therefore, the ability to manage the level of risk to minimize losses while maximizing profits is a key skill for any trader.
How does a trader do it?
Risk management can include setting the right position size, setting stop losses, and controlling emotions when entering and exiting positions.
Why does it matter?
If implemented correctly, these measures can be the difference between a profitable trade and losing everything.
Drawdown vs. recovery The number one reason most traders fail is the lack of risk management rules... Any successful trader will tell you the same thing.
As traders, we are professional risk managers. Without established risk management rules, we fail. It's simple.
Drawdown > also known as "DD" is a measure of price decline, it counts for both balance and equity (this can vary), so let's say you enter a trade, you risk £500, and the price falls to -£250, then it comes back up, reaches your take profit, and you exit the trade...
In any case, that -£250 drop counts as a drawdown, even if you still won the trade... It also counts for losses, so if you entered a trade with £250 on the line and lost, your DD would be -£250.
The Recovery Factor > is how much profit you need to get back to breakeven. Let's say you lost -1%, you need to return +1% to get back to breakeven.
The lesson is to set limits for yourself and understand the risks involved. For me, if I lose -1.5% in a day, I stop trading and come back the next day (I risk 0.5%).
Please stick to your rules. This is a business, treat it as a business. Many people just keep trading and trading and trading, it's a gamble and it's not good, it's called over-trading...
At the end of the day your trade should have only 4 results:
- big win
- a small gain
- break-even
- small loss
Getting rid of big losses will keep you in the game for years to come. Regardless of the size of your account, treat it with respect. If you can't manage risk in a "small" account, you can't do it in a large account. Prove to yourself that you are capable of managing BIG funds.