So we know that risk management will make us money in the long run, but now we’d like to show you the other side of things.
What would happen if you didn’t use risk management rules? Consider this example:
Let’s say you have $100,000 and you lose $50,000. What percentage of your account have you lost?
The answer is 50%.
This is what traders call a drawdown.A drawdown is the reduction of one’s capital after a series of losing trades.
This is normally calculated by getting the difference between a relative peak in capital minus a relative trough.
Traders normally note this down as a percentage of their trading account.
In trading, we are always looking for an EDGE. That is the whole reason why traders develop systems.
A trading system that is 70% profitable sounds like a very good edge to have. But just because your trading system is 70% profitable, does that mean for every 100 trades you make, you will win 7 out of every 10?
Not necessarily! How do you know which 70 out of those 100 trades will be winners?
The answer is that you don’t. You could lose the first 30 trades in a row and win the remaining 70.
That would still give you a 70% profitable system, but you have to ask yourself, “Would you still be in the game if you lost 30 trades in a row?”
This is why risk management is so important. No matter what system you use, you will eventually have a losing streak.
Even professional poker players who make their living through poker go through horrible losing streaks, and yet they still end up profitable.
The reason is that good poker players practice risk management because they know that they will not win every tournament they play.
Instead, they only risk a small percentage of their total bankroll so that they can survive those losing streaks.
This is what you must do as a trader.
Drawdowns are part of trading.
The key to being a successful forex trader is coming up with trading plan that enables you to withstand these periods of large losses. And part of your trading plan is having risk management rules in place.
Only risk a small percentage of your “trading bankroll” so that you can survive your losing streaks.
Remember that if you practice strict money management rules, you will become the casino and in the long run, “you will always win.”
Never Risk More Than 1% Per Trade.
A 1000USD account should have a maximum 100usd risk per trade and at least maximum 2% overall daily drawdown.
The best method of controlling your drawdown is to utilize an excellent expert advisor or software. I highly recommend Heist Supply demand EA.
The reality of trading is that if you stick to 1 strategy, there is absolutely no way that you will lose all you trades but we have to beware of the fact that you will come across a losing streak which you will need to protect yourself against so that you still have enough money left in your trading account when your winning streak comes. Avoid trading based on hope by unnecessarily holding losing trades.
Risking 2% vs. 10% Per day.
|TRADE #||TOTAL ACCOUNT||2% RISK ON EACH TRADE||TRADE #||TOTAL ACCOUNT||10% RISK ON EACH TRADE|
You can see that there is a big difference between risking 2% of your account compared to risking 10% of your account on a single trade!If you happened to go through a losing streak and lost only 19 trades in a row, you would’ve gone from starting with $20,000 to have only $3,002 left if you risked 10% on each trade.
You would’ve lost over 85% of your account!
If you risked only 2% you would’ve still had $13,903 which is only a 30% loss of your total account.
Of course, the last thing we want to do is to lose 19 trades in a row, but even if you only lost 5 trades in a row, look at the difference between risking 2% and 10%.
If you risked 2% you would still have $18,447.
If you risked 10% you would only have $13,122.
That’s less than what you would’ve had even if you lost all 19 trades and risked only 2% of your account!
The point of this illustration is that you want to set up your risk management rules so that when you do have a drawdown period, you will still have enough capital to stay in the game.
Can you imagine if you lost 85% of your account?!!
You would have to make 566% on what you are left with in order to get back to breakeven!
WHAT WOULD I NEED TO DO TO BREAKEVEN?
Trust us, you do NOT want to be in that position.
Here is a table that will illustrate what percentage you would have to make to break even if you were to lose a certain percentage of your account.
|LOSS OF CAPITAL||% REQUIRED TO GET BACK TO BREAKEVEN|
You can see that the more you lose, the harder it is to make it back to your original account size.
This is all the more reason that you should do everything you can to PROTECT your account. Using a kerese markets EA will give you access to all the required tools to protect your accounts.
By now, we hope you have gotten it drilled into your head that you should only risk a small percentage of your account per trade so that you can survive your losing streaks and also avoid a large drawdown in your account.
Remember, you want to be the casino… NOT the gambler!