Risk management is a vital part of trading success. Keeping losses small and protecting your capital will not only help you grow your account but also prevent you from giving back to the market what you got. This is a quick guide on how you can do that.
First, you need to decide your position size and by that I mean how much you want to risk on a particular trade be it 0.5%, 1%, 2% and so on. You decide based on your conviction in that trade idea, but if you're not yet experienced in that part, you can just use a fixed percentage for all your trades.
Second, decide where you're going to put your stop loss compared to your entry. For example, I personally use both the ADR (average daily range) and some technicals just for structure, so that my stop loss is neither too close nor too far as you should give your trades some room “to breath”. If you put your stop losses too close, you increase your risk of being stopped out prematurely.
Your trade size will be calculated based on the distance between your entry, your stop loss and the amount you decided to risk, so in the end if you end up being stopped out you lose only that planned amount. Never move your stop loss further out if the price is going against you.
Third, for entries some use technicals and some catalysts (fundamental developments like economic data, news, reports and so on). I prefer catalysts because I can expect if that particular thing will move the market in my direction. If it starts to do the opposite and it even breaks the levels I marked as kind of barriers, then I cut the trade because it's not playing out as I expected it to.
There’s no reason for me to keep the trade active because of hope and end up taking the full loss. I just close it even if in loss and move on to the next opportunity. That's how you keep losses small. As Paul Tudor Jones once said “never wishing, always trading”.
For a technical entry it would be kind of the same, so if the price starts to go in the opposite direction and it breaches strong levels that you expected to hold, then it's better to close and move on.
If you use catalysts, you have the reason in that moment to trade, while with a technical entry you can never know which level will hold, so you end up taking more losses and being stopped out more often and that will also make you overtrade as you will take more entries. Waiting for catalysts prevents you from overtrading.
This article was written by Giuseppe Dellamotta.