Risk Management for Traders

Why it matters

Accounts usually do not blow up from one trade. It is normally a series of losses that keep growing because nothing limits them. Sometimes it is one oversized loss that does the damage right away. Either way the problem is the same. How much you lose per trade, and how those losses compound over time.

The goal is to stay in the market long enough for your edge to play out. Your edge is what your strategy produces over a large enough sample of trades. It does not show up in three trades. It shows up across dozens. Losing streaks and drawdowns are normal. A drawdown is the decline in your account from a recent high. What decides whether you keep trading is not the streak itself. It is how much damage the streak causes.

It is a control system, not a way to avoid losses

Small controlled losses are manageable and recoverable. Large uncontrolled losses are difficult to come back from. Risk management is not about avoiding losses, because losses are part of trading. And it cannot fix a strategy with no positive tested expectancy. Tested expectancy is the average dollar result a strategy produces over a large sample when every trade follows the rules. If that number is negative, risking less will not make the strategy profitable. It will only lose more slowly.

The three decisions in this guide

Risk management on a single trade comes down to three choices, each covered in its own guide below.

• How Much to Risk Per Trade Why most traders cap risk at 1% of the account, shown with the drawdown math, and how to set your number.
• How to Calculate Position Size Turn your risk per trade and stop distance into the exact number of shares to buy.
• Where to Place Your Stop Loss Place the stop at the price that proves the trade wrong, from structure, and never widen it.

Coming next in this category. Daily and weekly loss limits, and scaling your risk by setup grade.