Are you struggling with your trading account? Are you feeling overwhelmed, frustrated, and ready to give up on trading altogether? Today’s lesson, if understood and implemented correctly, could provide you with the necessary knowledge to save your trading account and start rebuilding it.
Statistics show that 90-95% of individuals who trade in the financial markets fail in the long run. The primary cause of this widespread failure is often inadequate risk management skills. Many traders fail to grasp the significance and power of risk management.
Therefore, in today’s lesson, we will delve into the crucial but often overlooked topic of risk management. Despite its reputation as a dull subject, it is essential for making money in trading. Forget about the buzz and various trading systems, as we will be exploring the most crucial aspect of trading in the following paragraphs.
Don’t Star a war before you can win the battle…
Success in trading relies on three key elements: technical ability, money management, and mental or psychological aspect. Technical ability involves understanding chart reading, price action trading, or any preferred trading strategy. In my case, I teach and utilize price action strategies. Money management encompasses vital concepts such as risk management, position sizing, stop loss placement, and profit targets, with the primary goal of preserving capital. Finally, the mental aspect, or trading psychology, is intertwined with the other two elements, and without proper consideration of one, the others become ineffective.
Of the three elements discussed, money management is arguably the most crucial. Neglecting to focus on money management can lead to a flawed mindset and render technical skills useless.
Before engaging in trading with real money, it is crucial to ask yourself if you are truly prepared to win. Unfortunately, many traders dive into the market without proper preparation and end up losing. It is imperative to grasp the concepts covered in this lesson and in advanced trading courses to ensure success in trading.
Never leave your door unlocked…
It would be foolish to leave one’s most valuable possessions undefended, like a castle’s riches, when going to war. This same principle applies to trading, as protecting and growing one’s trading account should be the first priority. Before executing potential winning trades, traders must ensure their defense is in place.
To do this, traders should have a comprehensive trading plan in place before engaging in live trading with real money. This plan should outline essential elements such as the maximum risk per trade, the amount of money that the trader is comfortable losing in any given trade, and the necessary conditions for triggering a trade.
To ensure a strong defense, traders should only enter the market when they have a high probability of success and a well-defined trading edge. It is important to acknowledge that there is always the potential for loss in any trade, and having a solid trading plan in place can minimize the risk. For more information on creating a comprehensive trading plan, check out the trading plan template provided in our courses.
Being a “Good Trader” Just isn’t enough anymore…
Excessive leverage, also referred to as taking “unwise” or extremely large risks, is a leading cause of trading account failures and blowouts. Even the most skilled traders can fall victim to this practice and end up losing all their money or their clients’ funds. In some cases, this is also coupled with fraud.
In his blog “The Naked Dollar,” author Scott C. Johnston highlights how many high-profile hedge fund managers have lost hundreds of millions of dollars due to poor capital protection. One overconfident trader can easily make a mistake and put on a heavily leveraged position that leads to disaster.
It’s important to note that there are many skilled traders in the world who work for major banks and investment firms such as Goldman Sachs. However, not all of them are able to generate substantial returns in the long run due to their inability to properly manage risk, plan for losses, and execute effective capital preservation strategies consistently. Being a good trader goes beyond just reading charts and predicting market movements. It involves effectively managing risk, controlling market exposure, and consistently practicing capital preservation.
Poor capital preservation skills lead to failure in trading. It’s that simple. Even the best chart technicians and market analysts can fall short if they don’t prioritize capital preservation and consistently apply it to every trade. To be successful in the market, capital preservation must be a top priority and consistently practiced.
Why I Get Super Amped About Risk Management!
Contrary to common belief, risk management is not only crucial, but also intriguing and exhilarating. The reason is simple – it’s what drives profits in the markets.
Unfortunately, many traders overlook the importance of risk management, treating it as a task to be addressed later or using other trivial excuses. However, it should be their top priority. This often stems from their lack of understanding of the significance of effective money management.
Let’s delve into the subject to emphasize its importance:
How to Make the Most of Risk Management and Why It Is So Effective:
To consistently earn a livelihood through trading, the key is to maintain a long-term presence in the markets and let your advantageous edge work to your benefit. Unfortunately, many traders fail to achieve this goal as they lack proper risk management skills, leading to account blowouts.
Making money as a trader involves adhering to the following principles:
- Control your losses by pre-determining a 1R risk amount, which represents the maximum dollar amount you are willing to lose on a trade.
- Implement your advantageous edge consistently and allow it to play out over time, leading to larger profits among smaller losses.
Contrary to popular belief, winning percentage is not the most crucial factor. In the illustration below, a trader with a 20% win rate still achieved profitability through stringent capital management. A key component of successful trading is to cultivate an unwavering focus on capital preservation. This means determining a maximum 1R dollar risk and limiting the amount of money you risk on each trade to this amount or less. The image below shows that, even with more losses than wins, consistent and disciplined capital preservation led to the winners compensating for the losers.
How exactly does one go about managing their money?
My extensive writings on money management include discussions on several important topics, including:
- Risk/Reward – This is a key metric used to evaluate the risk and potential reward of a trade. If the risk/reward ratio is not favorable, it is best to skip the trade and look for a better opportunity. For more information, see the related articles.
- The 2% Rule vs. Fixed Risk – There are various approaches to risk management, but many are not effective and can harm inexperienced traders. In this article, we discuss why the popular 2% rule may not be the best method for controlling risk per trade.
- Stop Loss Placement – The placement of a stop loss order has a direct impact on risk management, as it determines the position size and therefore the amount of money being risked on a trade. Learn more about this topic in the linked article.
- Position Sizing – This refers to the process of determining the number of lots or contracts to trade on a particular trade. It is the combination of stop loss distance and position size that determines the amount of money being risked. For more information, see the linked article.
- Profit Target Placement – Setting profit targets can be complex, but it is important to have a clear understanding of the process in order to make it easier. Learn more about this topic in the linked article.
- The Psychology of Trade Exits – Exiting a trade can be challenging and often involves psychological factors. In this article, we discuss everything you need to know about trade exits, including the psychology involved, in order to be successful.
Many traders allocate an excessive amount of attention and effort to the wrong elements of trading. While it is crucial to have a solid understanding of trading strategies, trade entries, and technical analysis, these components alone are insufficient to generate consistent profits in the market. The key to successful trading lies in effective risk management, and it is important for traders to understand and integrate this aspect into their trading approach.
To gain a comprehensive understanding of how price action trading, trading psychology, and money management interplay, further training and education is necessary. To begin your journey, consider enrolling in an advanced price action trading course and learn how professionals approach and execute trades in the market. This can help you break free from the repetitive cycle of poor risk management and elevate your trading to a professional level.
17 thoughts on “How Risk Management Can Save Your Trading Account”
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