Risk Management 101

Risk management is the foundation of successful trading. No matter how good your strategy is, poor risk management will eventually lead to losses. In this guide, we'll cover the fundamental principles of protecting your capital.

The Golden Rule: Preserve Your Capital

The first rule of trading is simple: Don't lose money. The second rule is: Don't forget the first rule.

Capital preservation should be your top priority because:

• You can't trade without capital
• Large losses require exponentially larger gains to recover
• Consistent small wins compound over time

Position Sizing

Position sizing determines how much of your capital you risk on each trade. Here are the key principles:

The 1-2% Rule

Never risk more than 1-2% of your total capital on a single trade. If you have a $10,000 account:

• 1% risk = $100 per trade
• 2% risk = $200 per trade

This ensures that even a string of losses won't devastate your account.

Calculate Your Position Size

Use this formula:

Position Size = (Account Size × Risk %) / (Entry Price - Stop Loss)

For example, with a $10,000 account, 1% risk ($100), entering at $50 with a stop loss at $48:

Position Size = ($10,000 × 0.01) / ($50 - $48) = $100 / $2 = 50 shares

Stop Losses: Your Safety Net

A stop loss is a predetermined price at which you'll exit a losing trade. Key points:

• Always use stops: Never enter a trade without knowing your exit
• Honor your stops: Don't move them further away when hit
• Technical levels: Place stops beyond support/resistance
• Volatility-based: Use ATR (Average True Range) for dynamic stops

Risk-Reward Ratio

Your risk-reward ratio compares potential profit to potential loss. Aim for at least 1:2, meaning:

• Risk: $100
• Potential Reward: $200+

This allows you to be profitable even with a win rate below 50%.

Diversification

Don't put all your eggs in one basket:

• Multiple assets: Trade different instruments
• Various strategies: Use different approaches
• Time frames: Mix day trades with swing trades
• Uncorrelated markets: Reduce overall portfolio risk

Common Risk Management Mistakes

Avoid these pitfalls:

1. Risking too much: Going beyond 1-2% per trade
2. No stop losses: Hoping a losing trade will recover
3. Revenge trading: Increasing position size after losses
4. Ignoring correlation: Multiple correlated positions = concentrated risk
5. Over-leveraging: Using too much margin

Creating Your Risk Management Plan

Document your rules clearly:

1. Maximum risk per trade (1-2%)
2. Maximum daily loss limit (stop trading if hit)
3. Maximum number of open positions
4. Position sizing formula
5. Stop loss methodology

Track Your Risk Metrics

Use a trading journal to monitor:

• Maximum drawdown: Largest peak-to-trough decline
• Risk of ruin: Probability of losing your entire account
• Sharpe ratio: Risk-adjusted returns
• Average R-multiple: Average profit/loss relative to risk

Conclusion

Risk management isn't glamorous, but it's what separates professionals from amateurs. By implementing strict risk controls and tracking them in your journal, you give yourself the best chance of long-term success.

Remember: In trading, the goal isn't to make money—it's to not lose money. The profits will follow naturally from good risk management and consistent execution.

Start protecting your capital today with TradeXLM's integrated risk management tools and journaling features.