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!:
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:
Example Risk Mangement 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.