T2W Trading Community

If we are losing 40% of the time then we need to control risk! This is done through implementing stops and controlling position size. We never really know which trades will be profitable. As a result, we have to control risk on every trade regardless of how sure we think the trade will be. If our winning trades are higher than our losing trades, we can do very well with a 60% trading system win to loss ratio. In fact with risk control, we can sustain multiple losses in a row without it devastating our trading account and our emotions.

Some traders can start and end their trading careers in just one month! By not controlling risk and by using improper "Trade Size" a trader can go broke in no time. It usually happens like this; they begin trading, get five losses in a row, don't use proper position size and don't cut their losses soon enough. After five devastating losses in a row, they're trading capital is now too low to continue trading. It can happen that quickly!

It is equally important that the trader is comfortable with their trading system and have the knowledge to know that it is possible and inevitable to have a losing streak of five losses in a row. This is called drawdown. Knowing this eventuality prepares the trader to control their risk and not abandon their chosen trading system when it occurs. It is another ingredient in "The Trader's Mindset."

What we are striving for is a balanced growth in the trader's equity curve over time.

Below is a list of the ingredients in devising a sound money management plan for your trading:

1. Always use stops
2. Determine your "Trade Size" based on your trading account equity, your stop loss price for every trade
3. Never exceed a loss of 2% on any given trade
4. Never trade more than 2% on any give sector
5. Never exceed a total portfolio risk of 6%
6. Always trade with risk capital, money you can afford to lose
7. Never trade with borrowed money
8. Don't overtrade based on the time frame you have chosen to trade
   

"Trade Size" And The 2% Risk Rule

The two percent risk rule along with the six percent portfolio risk rule are shown to keep a trader out of trouble provided their trading system can produce 55% or above win to loss ratio with an average win of at least 1.6 to 1.0 meaning wins are 60% larger than loses. So, for every dollar you lose when you have a losing trade, your winning trades produce a dollar and sixty cents.

Assuming the above, we can then proceed to calculate risk. The two percent risk is calculated by knowing your trade entry price and your initial stop loss exit price. The difference of the two gives you a number that when multiplied by your position size (shares or contracts) will give you your dollar loss if you are stopped out. That dollar loss must be no larger than two percent of the equity in your trading account. It has nothing to do with leverage, and in fact you can use leverage and still stay within a two percent risk of equity in your trading account.