Risk Management and Position Sizing

A concept that many new traders overlook is Position Sizing & Risk Management. As a new trader, the main focus is always “How much can I make from this trade?”. This is a very short-lived approach that is no different than gambling. Over 90% of traders are not profitable. What sets the profitable traders apart from the non-profitable traders is not a secret strategy – it is sound risk management. In the market, there are no rules so in order to be successful you must make your own rules. Unfortunately risk management is not the appealing side of trading but if you want to truly find success and grow your account you must learn it.

Risk Management Position Sizing

Focusing On Risk

So why do we focus on the risk instead of the potential gain? When you are trading stocks – you are playing a game of probabilities. Not a single trader knows for a fact if a trade will work or not. That is why you trade when you have an edge. You want to do whatever you can to keep the odds in your favor so that you are consistently profitable. This requires strict discipline that most people don’t have which is why the statistics are the way that they are.

Define Your Risk

The rules that I am going to explain here are the rules that we follow. There are many many ways to practice proper risk management and it all depends on your own personal progress and your own personality but this is the way that we stay consistently profitable:
A question we get a lot is what percent of my account should I allocate to each trade? We don’t focus on the percent invested – we focus on the percent at risk. We generally risk around 1% of our portfolio per trade. As I said above you never know for sure if a trade will be a success or a fail so you don’t want to risk so much that a few failed trades set you back a big amount. We find that generally, 1% for swings and positions is a good amount to risk for us.

The key for us is to keep your risk even for all of your trades. If you are risking $500 on half of your trades and $1200 on the other half and the half you risked more on doesn’t work out in your favor then despite the gains in the other half of your trades you still haven’t made any progress. We keep risk consistent throughout each trade so that way even if 6 out of 10 don’t work – you are still profitable in the end.

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Putting It All Together – Trading Mechanically

Now that you understand our personal risk management process – defining your risk beforehand and keeping the risk amount the same across all of your positions lets talk about how to get into that mechanical mindset and use it to your advantage.
You want to be a machine, no emotions should ever affect your decisions. When you don’t define your risk and don’t plan for the possible loss you are usually bothered when it doesn’t work out because you were expecting it to do what you wanted it to do. In order to get into the right mindset and leave your emotions at the door, I recommend setting your risk VERY low. Even if the amount is well below 1% of your account you want to get into the habit of getting stopped out and remaining unphased. To do that put your risk at an amount where you will not even flinch if it stops out. After a few weeks of doing this, you will slowly start to realize you are detaching yourself from emotional trading. It sounds silly but it works and is the first step to mechanical trading.

Final Thoughts

Opinions and emotions are detrimental when it comes to trading. You need to separate yourself from any sort of emotionally driven trades.
To do this you must focus on the risk and never the potential gain. Keep risk consistent throughout your trades. Stop expecting anything from the market and leave your emotions at the door. The result? Consistent results instead of chopping back and forth to nowhere and truly mechanical trading because you have already done the hardest part – accepting your risk.

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July 31, 2018