FXBug - Risk Management 101

By Aaron Hazell

Money management is by far one of the most valuable skills that you need to become a successful trader. Rather than focus on the pitfalls too much, and the bad habits which I'm sure we all have varying degrees of experience with, I just want to share a few basics along with a spreadsheet that is similar to what I use to track my progress. Hopefully this information can help a few people out.

Position Sizing & Chosen Risk

Q: Is there a magic % risk that you should use in your trades?

A: Yes.

Q: What is this magic % of risk you should use for your position sizes?

A: Well that's up to you. Searching over the internet or talking to experts will net you many different answers, the true answer is that you have to come up with your own level of risk. We all have our limits, we all have our own level of comfort, and to define our risk we must understand where we sit. Being prepared for the worst we have to rely on consistent trading and solid money management to avoid 'catastrophic drawdown'. We want to keep trading, and to keep those accounts growing.

Basic Considerations:

- Trade environment (is the trade probability high/low?)
- Size of your Account (you may want to alter risk based on Account balance)
- Your Skill level, know your win/loss ratio and what your comfort zone is.

The chart below is intended to be an eye opener if you have never thought about your risk in such a way. It's kind of scary, assuming you ALWAYS used stops of 30 pips exposing yourself to a risk of 5% would ensure 50% of your account was gone after 10 losses in a row. Many newcomers even exceed 5% risk, which nearly cements their path to failure even faster. To avoid such a plight when choosing our position sizes, we must find a level of risk that takes into account all factors such as account size, our consistency in successful trades, our comfort level with the risk, and of course the trade environment - you can adjust your risk for higher or lower probability trades. With all factors considered our account will be intact and our consistent disciplined trading will net us great profits.

Risk Example based on Account balance of $10,000

* - Standard mini-lots (10,000 units) you would have to round up/down to whole number unless your broker lets you deal in micro lots (1 unit).

If you are relatively new and haven't learned the lesson yet please take note: Start SMALL, begin with an account of 1000$ or even less until you have proven to yourself that you can trade consistently with positive results (on a live account when you're ready - consistent demo trading doesn't count). It's all relative and it's just as easy to blow $10000 savings learning to trade as it is $1000. The only difference is that it's easier to fund that $1000 to start again after the inevitable failure. Also take note, its common knowledge that 90-95% of traders blow out their first accounts or at least drain them severely so you would be wise to start small.

Read on to page 2 for personal review and setting targets.