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Risk and Money Management Rules

Risk and Money Management Rules

Money management rules are an essential element of any trading strategy.

“Attention to profit is a sign of immaturity, while attention to loss is a sign of experience.”

Alan Farley

Content:

1. Money management rules
2. How to calculate the lot correctly
3. How to calculate risk per trade
4. How to calculate risk per day
5. How to calculate risk/reward ratio

MONEY MANAGEMENT RULES

1. You should risk only a portion of your money. It may sound like a no-brainer, yet there are still those daredevils who manage to enter one trade with a half of their funds. It doesn’t take a genius to imagine the outcome of such a step.

2. Make sure to consider the consequences of the future risk more often. And by «more often» we mean before making every trade. When opening a new position in the market, you need to understand that you can get losses, and come to terms with it.

3. Do not risk a great deal of money to earn just a little. It is important to evaluate the prospects of a future position, and whether it will generate bigger profit than the risk you take per trade.

For instance, if your risk on a trade is $10, can a goal of $30 be achievable? These factors must obviously be calculated based on your statistics.

4. Make decision when you are 100 % sure it is right. Of course, it is easier said than done. However, you just have to stick to the rules of your own trading system at all times.

The doubts arise when you don’t have clear rules to follow or have not tested out your trading strategy sufficiently.

5. Consider every possible scenario. Trading is a situational business. In the Forex market, there will always be several scenarios of the trader’s behavior in a certain situation. Put simply, never rule out the possibility that the price may reverse and go against your trading plan.

After having a brief theory revision, we are going to get down to practicing. But first, let’s take a look at the mechanism for calculating trading risks, for it will lay the very foundation for personal settings of the risk management service.

What should a trader keep in mind in order to avoid losing the deposit?

“My experience with novice traders is that they trade three to five times too big. They are taking

5 to 10 percent risks on a trade when they should be taking 1 to 2 percent risks.”

Bruce Kovner, wealth estimated at $4,3 billion


Become the client at Gerchik & Co


HOW TO CALCULATE THE LOT CORRECTLY

Typically, the position volume is calculated from the risk of loss i.e. size of the stop loss.

E.g. you have a deposit of 10,000 of some units and you decide to lose no more than 2 % per trade or day. According to calculation, 2 % of 10,000 equal 200. So, for example, if the stop loss is 20 pips, the lot will be equal to 1.

Why is that so? 1 lot equals $10 per pip. If we lose 200 in case of 20 pips, one pip equals $10. Risk Manager includes risk settings both in percentage and in currency terms.

HOW TO CALCULATE RISK PER TRADE

This risk determines the maximum value of losses per trade. Let’s try to figure out what this parameter is for.

If your deposit is $10,000, and the risk per trade is 10 % of the deposit i.e. $1000, you will lose the deposit, if you face a series of losing trades back to back.

In case your risk is 1 % of the deposit, making 100 unprofitable trades won’t be as easy if you follow the rules of the trading strategy.

So, the recommended value of the maximum loss per day for a conservative trader is up to 2 %, but it better be less.

Thus, the risk per trade is calculated by dividing the maximum daily losses by the number of trades made per day. If there are 3 trades, we divide 2 % by 3 and get 0.6 on average.

HOW TO CALCULATE RISK PER DAY

If you ask any trader how much money he or she loses the most per day, you might not get a meaningful response. The majority of them neglect the money management rules.

It is advised to determine the risk of loss per day based on statistics. If you still get many losing trades, you need to reduce your daily risk to at least 1 %.

HOW TO CALCULATE RISK/REWARD RATIO

In order to avoid losing your trading deposit, you have to be able to get back in the saddle quickly or preserve a portion of your profits. To achieve that, you should not lose more than 2/3 of the daily profit per day.

Here’s why. If your risk/reward ratio is 1:3 and you risk no more two portions of the profit per day, you will save one portion of the profit on unprofitable day.

On the next day, in case of a favorable outcome, you get a positive result in two days, if you get at least one of two profitable trades. Even in the presence of 30 % profitable trades out of a hundred.

E.g. there are 20 trades a month and 6 of them are profitable, so 14 of them are loss-making. Thus, by maintaining 1:3 ratio, we get:

  • 6 x 3 = 18 risks from profitable trades;
  • 14 risks lost;
  • 18 risks of profit – 14 losing trades = 4 (therefore, you did not lose the money, and even ended up in the black).

By keeping your statistics in check, you will be able to work with these parameters, increasing the number of profitable trades or the expected value (risk/reward ratio).

FOR BETTER RETENTION OF THE ABOVE MATERIAL, MAKE SURE TO WATCH WEBINAR BY VIKTOR MAKEEV DOWN BELOW

 

What to know:


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using Risk Manager brought to you by Gerchik & Co!


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