Risk Management: The Importance of Sizing Your Trading Positions Correctly

Risk Management

Risk management is an essential component of any successful trading strategy. Small losers are just as important as the big winners on the path to becoming a  consistently profitable trader. Effective risk management cannot happen unless you are comfortable losing the money you plan to risk.

Newer, under capitalized traders are especially prone to inappropriate sizing. This causes them to trade emotionally, make poor decisions, and prevent them from letting their trades play out to their full potential.   

Set Realistic Expectations: You Cannot Avoid Losing Trades

Losing money is apart of trading. No strategy wins 100% of the time. Therefore, to become a successful trader, you must become comfortable and familiar with losing. A big part of this process is sizing your trades appropriately based on your account size and risk tolerance. You cannot get $1000 winners by risking $5 on a trade.

Most successful trading systems will consistently give 2:1 and 3:1 on your risk, so adjust your expectations accordingly. To make that $1000, you will probably have to risk around $500. Don’t let any random twitter guru fool you into thinking that you can make $500 a day with a $2000 account when you are inexperienced.   

Be Comfortable With What You’re Risking

If you have a $5000 account you don’t want to be risking $500 on a trade. If you’re risking 10% of your account, you will not be able to manage risk correctly because you will be far more emotional than if you were risking $100. You will most likely stop out too early because it went a few ticks against you and you got scared, or you might freeze and not do anything when you are supposed to be stopping out for the loss. Nothing should change in your life if you lost the money you decide to risk on a trade. 

If you risking $100 instead on a trade, you will not be devastated if you take the loss, and your buying power won’t be crushed. If you feel like you can’t leave the position you have on for a few seconds,  you’re trading with too much size. Everyone has different risk tolerance, and building size takes time. You cannot go from risking $100 per trade to risking $1000 per trade over night. You want to gradually increase your risk as your account grows and you become more consistent.  

Use Hard Stops and Hide Your Unrealized PnL

Using hard stops (especially if new) will help you learn to accept the risk you’re putting on. This will help you micromanage your trade less and let your trades play out to their full potential. Once you enter your trade, immediately set your stop, set a limit order for your first profit target, and let the trade play out. The trade either works or it doesn’t.

Hiding your unrealized PnL will also help you embrace your risk and let you let your trades play out with less emotional attachment to the money on the line. These things will not just help you become a more profitable trader, but will make trading a more relaxing and less stressful experience as well.   

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