Risk Management

You can have a strategy that wins only 40% of the time and still be profitable — if your winners are significantly larger than your losers. Conversely, you can win 80% of the time and still blow your account if your losses are enormous.

Risk management is the difference between a trader who survives long enough to develop skill and one who loses everything in the first month. Capital preservation is the primary objective.

The goal is not to make money on every trade. The goal is to stay in the game long enough for your edge to play out over hundreds of trades.

Position sizing determines how much of your capital you risk on a single trade. The standard rule is to risk no more than 1–2% of your total capital on any single trade.

Example: if you have $10,000 and risk 1% per trade, you risk $100 per trade. If your stop-loss is 5% below your entry, your position size is $100 / 0.05 = $2,000.

This formula ensures that even a streak of 10 consecutive losses only reduces your account by 10%, which is recoverable. Risking 10% per trade means 10 losses wipes you out.

A stop-loss is an order that automatically closes your position if price moves against you by a defined amount. It is not optional — it is the mechanism that enforces your risk management rules.

Place stop-losses at technically meaningful levels, not arbitrary percentages. A stop below a key support level makes structural sense. A stop exactly 2% below entry is arbitrary and easily triggered by normal volatility.

Never move a stop-loss further away from your entry to "give the trade more room." This is how small losses become catastrophic ones.

The risk-reward ratio compares the potential profit of a trade to its potential loss. A 1:2 ratio means you risk $1 to potentially make $2. A 1:3 ratio means you risk $1 to potentially make $3.

With a 1:2 risk-reward ratio, you only need to win 34% of your trades to break even (before fees). With 1:3, you only need to win 25%. This is why high risk-reward ratios are so powerful.

Before entering any trade, calculate your risk-reward ratio. If it is below 1:1.5, the trade is generally not worth taking — the math does not support it over time.

Drawdown is the peak-to-trough decline in your account value. A 10% drawdown requires an 11% gain to recover. A 50% drawdown requires a 100% gain to recover. A 90% drawdown requires a 900% gain.

This asymmetry is why limiting drawdown is so critical. Keeping maximum drawdown below 20% is a reasonable target for most traders.

Track your drawdown as carefully as you track your profits. A trader who never loses more than 15% of their account in a drawdown will survive long enough to compound their gains.