How to Manage Risk in Trading - Wanderer Financial

Risk Management — A Simple How to Guide

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If I lose 5% on a trade then I need a 5% winner to get back to even. Right? Wrong.

There’s some pretty simple math we can use to show you how you can manage risk and why risk management is so critical to our trading success. It highlights exactly why we need to keep our losses small and let our winners run.

Small losses are easier to recover from than big drops.

Let’s say you’ve got a $100,000 account and you lose 3% on a trade. You now have $97,000. To get back to $100,000 now requires a 3.1% win (3,000/97,000). That’s not such a big deal, right? A 3.1% gain instead of 3%.

But what if we let that same loss turn into a 20% loser instead of cutting it off early? Our $100,000 drops to $80,000. Now to get back to $100,000 requires a 25% win (20,000/80,000).

Let’s really get extreme. You lose 50% on the trade. $100,000 turns into $50,000, and now to get back to even you need a 100% winner.

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It’s psychology that keeps us in losing trades. Our minds are not conditioned to accept losses and admit we are wrong. But in trading it’s only those that can do both of those things that will be around year after year. The easiest way to avoid letting emotions overcome common sense is to always use stops when trading. Know before we enter a trade exactly where our exit is, then enter the stop order right away to take the decision out of our hands and leave it up to the markets to decide. Use stops, let your winners run, and lock in your profits.