Discussions regarding how much of our account we should risk on an individual trade are as old (and lively) as the modern day trading industry. Many experienced, successful traders and analysts will suggest a fixed amount of risk, whilst some will suggest that it should be variable, or both. But one aspect of trading that all experienced and successful traders would agree on is that risk, as part of the money management discipline we embed into our trading plan, is a detail we should pay a lot more attention to, far more attention than the majority of traders appear to dedicate towards what is such a critical success factor.
It’s important (as always) that traders don’t become influenced by traders on blogs or forums citing risk of circa 10% per trade. Similarly our traders should not contemplate a level of risk based on a ‘hunch’, or a level that others’ appear to be using. The level of risk should be laid out in the trading plan and be directed by the content in that trading plan.
It’s also important to stress that every trading account must be treated with the same level of respect irrespective of the account size. Placing a small percentage of your life savings into a trading account, but then using high leverage and high percentage of risk on that small account, is a poor policy. Firstly, it can prove difficult to constantly assess how much of the original savings is being risked per trade, secondly constantly topping up micro accounts early days can prove to be counterproductive.
How we decide on the risk that we’re prepared to take per trade is a tricky calculation to reach. Often it comes down to how quickly an individual trader wishes to grow their account. Experienced traders, who have maybe witnessed their accounts grow over a sustained period of years, may be willing to take on more risk knowing that the overall trading strategy they employ will always ‘come good’ after a short period in drawdown. Whereas new, inexperienced traders would struggle with high risk if it meant experiencing a significant drawdown, their equilibrium and confidence could be seriously knocked as a consequence.
There’s also another crucial aspect to consider; not just the risk per trade, but the overall level of risk. For example, a trader may be operating a strategy were they break down their risk over several currency pairs, as opposed to risking their full percentage risk on one currency pair trade only. Let us explain…
Our trader might be bullish euro and decide to divide up their risk by taking a position in not only EUR/USD, but also EUR/JPY, EUR/AUD EUR/GBP. In this way our trader is offsetting some of their risk and accidentally employing a crude form of hedging by the use of currency pair correlations. But in simple terms rather than risking the full percentage risk on one currency pair the risk is spread over several. Alternatively our trader might decide that their risk per trade stays rigid, at perhaps 1%, but our trader is prepared to risk a maximum of 4-5 per cent across several pairs. Rather than take all the positions immediately the alternative would be to wait for the same high probability set up to occur on each euro currency pair and take each trade accordingly as the set up occurs.
