Your survival as a trader depends on how you manage risk. The single most important aspect of trading is risk management.
Risk management is boring, overlooked by newbies, and ignored by the greedy. Greed without risk management will wipe out your account. The fact is traders have losses, even the most experienced traders. The difference between newbies and experienced traders is how they manage those losses.
If you are new to trading and you read only one thing on this website, then it should be this. The importance cannot be overstated.
Here’s a Fibonacci 5 risk management techniques:
1. Never ever risk more than 3-5% of equity on any one trade.
This rule ensures that with a series of 10 losses in a row a traders account will still have sufficient equity to be able to continue trading. While a series of 10 losses in a row is never expected and never a goal, it is a worst case scenario that must be considered. Would your account survive it?
2. Always use a stop loss.
What would the market have to do to prove you wrong? What is it that you think the market cannot do? Set your stop loss accordingly. Stops could be set just beyond Elliott wave invalidation points, just beyond an important prior high or low, using a trend line or a moving average.
Stop losses should be an order but may also be mental. If using a mental stop loss, the trader must have exceptional discipline to execute it at exactly the time emotion will be against you.
3. Exit a trade as soon as you recognise it has gone wrong.
Sometimes this happens before a stop loss is triggered. Sometimes market behaviour is not what you expected. This may be in terms of wave structure, volatility or anything that looks wrong. If it looks wrong and isn’t what you expected, then exit the trade promptly.
4. Don’t meet margin calls.
Experienced traders view margin calls as an objective indication that the trade has gone wrong. It it gets this bad, stop throwing good money at it!
5. Adjust position size to meet rule 1.
The importance of rule 1 cannot be overstated. Rule 5 really is a repeat of rule 1. Never ever risk more than 3-5% of your equity on any one trade. In order to keep this rule then of course a stop loss order must be used, otherwise potential risk is 100% of your equity. So really, rules 1, 2 and 5 are all the same.
When calculating equity take the value of your account minus all potential losses on all open positions. That is available equity for the next trade. Calculate 3-5% of this number and you have the amount which may be risked on the next trade.
Calculate the potential loss for a trade from the open price to the stop loss price (most trading platforms will do this for you). To keep this potential loss within 3-5% of equity adjust the size of your position.
Finally, one extra tip which is one of my personal favourites. When a position becomes reasonably profitable move your stop loss to break even or just beyond to protect a very small profit. In this way I have turned a series of potential losses into a series of tiny profits, finally getting a position that “sticks” to ride a trend. It may mean I have more tries at entering a trend than traders who can handle the pain of holding a losing trade for longer, but it does mean I sleep easier at night.
Experienced members are encouraged to add their own tips in comments below. Maybe you think there’s a really great tip I’ve not mentioned? Or maybe you think one of these tips could be said differently?