Trading Risk Management

Trading Risk Management Rules

6 min read

Trading risk management is essential to your long-term success, regardless of your type of trader. You must not over-trade and cut your losses when a trade goes against you. Let your winners run. Always shoot for at least a 1:2 risk/reward ratio, ideally 1:5. That means you risk $1 for the potential to make $5.

Trading risk management is often overlooked but essential in trading. It’s when a trader figures out the potential loss on a trade and then takes action or sometimes inaction. If you learn you can lose more than you’d make on a trade, you want to stay out. It’s especially important when you trade penny stocks. It doesn’t matter how good of a trader you are; you could lose everything in one bad trade.

Hence, it is important to protect your capital. You’re never going to make successful trades 100% of the time. Even the best traders in the world fail 30-40% of the time.

The difference between new and seasoned traders is the ability to limit risk. When starting, you soon learn that trading is emotional.

You won’t last very long if you let emotions rule your trading.

Limitation Is Key

There’s no removing risk in trading. You’re always going to be taking risks no matter what. Limiting risk is the key to being successful.

The stock market is a war between buyers and sellers. When you place a trade, you’re entering that battle. Hence, trading risk management is a lot like plotting your strategy.

Wars are won by having a winning strategy. If you go in willy-nilly, you’ll never achieve anything. It’s the same thing with trading. Managing risk is something that’s talked about a lot.

However, it’s not always followed. That may be a large part of why 90% of traders quit. You need to learn the basics of the stock market and trading risk management and apply them.

Sometimes, the most simple steps are often the most overlooked steps.

COURSE
Day Trading Course Options Trading Course Futures Trading Course
DESCRIPTION Learn how to read penny stock charts, premarket preparation, target buy and sell zones, scan for stocks to trade, and get ready for live day trading action
Learn how to buy and sell options, assignment options, implement vertical spreads, and the most popular strategies, and prepare for live options trading How to read futures charts, margin requirements, learn the COT report, indicators, and the most popular trading strategies, and prepare for live futures trading
INCLUDED

Plan Ahead

Part of trading risk management is to plan your trades ahead of time. Planning your trades before you take them can be the difference between success and failure.

You plan your trade and trade your plan. You’ll find that when you deviate from your plan, it’s often not a success. Why? You’re letting emotion control your decisions.

I always want to risk less than I can potentially make. Meaning I will look for a 2:1 at MINIMUM risk-reward ratio. So, if I can make a dollar, I will only risk 50 cents. Usually, I look for 3, 4, and 10:1 ratios. This means I can allow myself to risk 1 dollar and potentially make TEN dollars on the trade (per share).

Any good trader knows the price they are willing to pay ahead of time and what price they want to sell at. They have to look at the charts to see the probability of the stock hitting its desired price.

Patterns

When the return is, in fact, high enough, then place the trade. Hence, it is important to know what candlesticks mean.

Trading risk management doesn’t happen without candlesticks, patterns, and your willingness to look at profit and loss. Take a look at unsuccessful traders. What do they have in common?

They enter trades without figuring out their profit and loss targets. They have no idea when they’ll sell. This causes emotions to take over. When emotion dictates trades, you’re on your way to blowing up your brokerage account, especially if you’re trading stocks and options.

Trading Risk Management Chart

How Much Should You Risk on Each Trade?

How much should you risk on each trade? There isn’t a hard rule. However, a good guide is a 1:5 ratio. An example is to risk $0.10 for the potential to make $0.50. Or risk $1 for the potential to make $5. There isn’t a hard rule, but never risk too much in your account.

Stop Losses

Stop losses is one way to help with trading risk management. Setting a stop loss sets a price when you sell a trade taking a loss. If you’re only willing to risk 10 cents on a trade, you set your stop less than 10 cents below your entry.

The more you practice trading, the better you become. Then, you get to a point where you don’t have to make a stop-loss order. You can set mental stops for yourself and not tip off market markers.

A stop loss gets rid of the it’s going to reverse mentality. That kind of thinking is emotional. You can’t go about trading risk management while letting emotions dictate everything.

When stop losses are used correctly, you can minimize the number of trades because you’re not needlessly getting in and out of trades. This helps cut commission fees and helps if you’re limited in the amount of trades you’re allowed.

Setting your stop losses can depend on whether you’re bullish or bearish on stocks. Again, knowing whether to take a bullish or bearish position on a trade is all about being able to read charts and patterns.

Final Thoughts: Trading Risk Management

Support and resistance play a huge role in trading risk management. You won’t be a good trader if you can’t find support and resistance.

Those levels are how many traders find their profit and loss ratios. You’re always hearing “buy at support, sell at resistance.” If you’re shorting, then you sell at resistance and buy at support.

Support levels are great for setting a stop loss. Meanwhile, resistance is a great profit target. Many great trades are closing their positions when they reach resistance levels.

The importance of support and resistance can’t be stressed enough. Those levels can help to rationalize trades. If a stock is too close to resistance, you wait to take the trade.

Trading risk management means you’ve planned the trade before you executed it. Stick to your trading plan. It keeps emotions from clouding your judgment. A successful trader is methodical in their approach. Emotional traders don’t last. 

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