Risk Management Guide
Learn to protect your capital and survive losing streaks - the foundation of long-term trading success
Why Risk Management is #1
Risk management is the single most important factor in trading success. A mediocre strategy with excellent risk management will outperform a great strategy with poor risk management every time.
The goal of risk management is simple: ensure you can survive a string of losing trades. Every trader experiences losing streaks. The question is whether you'll still have capital when the streak ends.
Professional traders focus on capital preservation first, profits second. They know that without capital, you can't trade. Protecting your downside automatically improves your upside potential.
The Math of Recovery
The bigger the loss, the harder it is to recover. This table shows why protecting capital is crucial:
| Account Loss | Gain Needed to Recover | Difficulty |
|---|---|---|
| 10% | 11% gain | Easy |
| 20% | 25% gain | Moderate |
| 30% | 43% gain | Difficult |
| 50% | 100% gain | Very Hard |
| 75% | 300% gain | Nearly Impossible |
Core Risk Management Principles
The 1% Rule
Never risk more than 1-2% of your account on any single trade. This ensures survival through losing streaks.
Position Sizing
Calculate position size based on your stop loss, not your conviction. Risk determines size.
Always Use Stops
Every trade needs a stop loss set BEFORE entry. No exceptions. Hope is not a strategy.
Risk-Reward Ratio
Only take trades with 1:2 R:R minimum. This gives mathematical edge even with <50% win rate.
Daily Loss Limit
Set a maximum daily loss (e.g., 3%). Stop trading when hit. Live to trade another day.
Diversification
Don't put all capital in one trade. Spread risk across uncorrelated positions.
How to Calculate Position Size
Position Size = (Account × Risk %) ÷ Stop Distance
This formula ensures you risk a consistent percentage on every trade.
Example Calculation:
- Account Size: $10,000
- Risk Per Trade: 1% ($100)
- Entry Price: $50.00
- Stop Loss: $48.00
- Stop Distance: $2.00
- Position Size: $100 ÷ $2 = 50 shares
- Total Position: 50 × $50 = $2,500
- Max Loss: $100 (1%)
Key insight: Your position size is determined by your stop loss distance, not by how much you want to buy. Tighter stops allow larger positions; wider stops require smaller positions.
Stop Loss Strategies
Technical Stops
Place stops below support (longs) or above resistance (shorts). The stop should be at a level that invalidates your trade thesis. Best for most traders.
Volatility-Based Stops
Use ATR (Average True Range) to set stops based on volatility. Example: 2× ATR below entry. Adapts to current market conditions.
Time-Based Stops
Exit if the trade doesn't work within a certain time. If buying a breakout, exit if price doesn't continue within X bars. Prevents dead money.
Trailing Stops
Move stops up as the trade moves in your favor. Lock in profits while letting winners run. Can trail below swing lows or moving averages.
Pre-Trade Risk Checklist
Deadly Risk Management Mistakes
Avoid these account-killing errors at all costs:
Frequently Asked Questions
What is the 1% rule in trading?
The 1% rule means never risking more than 1% of your trading account on a single trade. If you have $10,000, your maximum loss per trade should be $100. This protects you from a string of losses wiping out your account.
How do I calculate position size?
Position size = (Account Size × Risk %) / (Entry Price - Stop Loss). For example: $10,000 × 1% / $2 stop distance = 50 shares. This ensures you never risk more than your predetermined amount.
Why is risk management important in trading?
Risk management is crucial because it keeps you in the game. Without it, a few bad trades can wipe out your account. Good risk management ensures you survive losing streaks and remain profitable long-term.
What is a good risk-reward ratio?
A minimum 1:2 risk-reward ratio is recommended. This means for every $1 risked, you target $2 profit. With 1:2 R:R, you only need to win 33% of trades to break even.
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Risk Disclosure: Trading involves substantial risk of loss and is not suitable for all investors. This content is for educational purposes only and does not constitute financial advice.
Last updated: December 2025