The Risk Factor

We here alot about managing risk, know your risk or have a good risk to reward ratio. I've been thinking about this and also thinking what really determines if a trader is successful or not. And you know what? It is that risk factor.

There are so many strategies out there, good and bad, but if risk is not controlled then you are setting up for failure and the strategy doesn't really matter. Why is managing risk so important? Let's look at a business. There is risk involved when you operate a business. For example, you buy materials to produce a product to sell. All your invested money, expenses, and work into that product is at risk. If no one buys the product you lose money and time you had invested. Yes, you still have the product but it's no good to you. You might have a sale and sell it cheap in order to attract buyers. You got rid of the product but took a lost at the same time. The big question after that is can you do it all over again? Can you still operate the business? Hopefully the answer is yes because although you took a lost, it was a small lost compared to what you would had made in profits. And because the lost was small you still have capital to make more products.

A successful trader is one that keeps his/her risk low and is able to stay in the trading business to trade for another day.
How do you determine your risk. Well, it is often recommend not to risk more than 2% of your total account value. So if your account is $5,000, you would only risk $100. In a sense you are saying you are willing to lose $100 for every trade or combination of trades.

In my demo futures account I've set the account value to $2000. I determined that I would only risk 1% of $2000 per trade which equates to $20. Easy math. If I trade the miniDow which 1 tick = $5, I would place my stop 4 ticks from entry (4 ticks = $20). If my risk/reward is 1:1 that is for every $20 at risk I make $20, and I made 4 trades in which 2 were losers, I would break even. If the my risk to reward ratio was 2:1, that is for every $20 at risk I make $40, and keeping the same 4 trades I would had come out with a profit of $40. The point is that I can still trade another day.

So, no matter the strategy please determine the maximum you are willing to lose on a trade. And let it be such that it doesn't break your bank if you were to lose often. Yes, your strategy is still important for you want a low risk/high reward strategy that even if your loses are small your wins are big. Amd the big wins would off set the loses. Please be warned that some strategies call for high risk low rewards. Such strategies would have to have more wins than losers in the long run. If they don't you will be out of business. I saw an automated forex strategy for Metatrader that has a 1:4 ratio. It made 20 pips a day but the stop was 80 pips away. You risked 4 for every 1 gained. NOT GOOD. The idea seemed good and it was giving good profits in backtest for certain periods but run it for other periods and it drained the bank. Please be careful. Another time I will stress the importance of a good strategy to suit your risk/reward ratio.

Happy Trading