Step 3. Risk Management and Your Trade Plan
Risk management is absolutely essential in successful trading. At the outset, all you need to do is simply define your risk management approach and any specific rules you intend to use.
It is especially important to evaluate your own risk tolerance and attitudes toward risk. Here are some questions to ask yourself—and be honest!:
About Me
- What is my attitude toward risk?
- What do low, medium and high risk mean to me?
With answers to these questions, you can begin to quantify your risk management parameters, taking a mathematical approach to assessing whether a particular trade is too risky for you. Consider how much leverage you’ll use, your maximum trade loss and your maximum day loss. For example, your risk vs. equity matrix on a per trade basis might look like this:
About My Risk Management Approach
- What proportion of my account am I prepared to risk on each trade?
- How many positions am I prepared to run at any one time?
- What is the maximum account exposure I am prepared to accept?
Example Risk Management Statement
I have a $10,000.00 account, and I am prepared to take a medium risk (3% risk) on any single trade. Therefore, the amount I am willing to lose on any single trade is $300.00 (i.e., 3% of my total equity of $10,000).
Another way of looking at risk is via a risk/reward ratio. Find out more in the Trading and Risk Management training module.