Most traders spend their time looking for the perfect entry. Experienced traders spend just as much time deciding how much they could lose. Risk management will not make every trade a winner, but it can stop a run of losing trades from ending your trading altogether.
The 1% guideline
A common rule of thumb is to risk no more than 1 to 2% of your account on any single trade. With a $5,000 account, 1% is $50. That means ten losing trades in a row would cost about 10% of your account. That is painful, but you can recover from it. Risking 10% per trade could wipe out most of the account in the same run.
Position sizing in three steps
- Decide where your stop-loss belongs, based on the chart rather than on how much you want to win.
- Measure the distance from entry to stop in pips (or points for indices and commodities).
- Divide your cash risk by that distance to find a position size that loses exactly your planned amount if the stop is hit.
Using stop-loss and take-profit orders
A stop-loss closes your trade automatically at a set price, so a single bad trade cannot run out of control. A take-profit closes it when a target is reached. Many traders look for setups where the potential reward is at least twice the risk. That way they can be wrong more often than right and still come out ahead.
Remember that in fast markets, or when the market gaps over a weekend, a stop may be filled at a worse price than requested. This is called slippage. Size positions with that possibility in mind.
Watch your total exposure
Five trades in highly related instruments, such as EUR/USD, GBP/USD and AUD/USD, can behave like one big trade against the US dollar. Add up the risk across related positions, not just trade by trade.
Keep a trading journal
- Record your entry, stop, target, position size and reason for each trade.
- Note how you felt: rushed, confident, frustrated.
- Review weekly to find the habits that cost you money.
Risk management is not exciting, but it is what gives your strategy the time to work. Protect your capital first, and let the opportunities come to you.
This article is for general education only and is not investment advice. Trading forex and CFDs carries a high risk of losing money.