How I Apply Risk Management

‘I risk a fixed, small portion of my portfolio on each trade… I raise my size if I’m trading well and seeing markets well; reduce my size if I’m not in sync with the markets. I make those adjustments very quickly. I want to ensure that, from peak to trough, I never go down more than 5%. I know that’s very conservative, but that’s worked well for me. I go for small, consistent returns – not home runs.” --- Brett N. Steenbarger


Hello:

Some asked me if I’m not worried about revealing my secrets. I’ll give them an answer in my next article. Back to the caption above, the way I apply my risk management is very simple. Your charts don’t need to look like Michelangelo’s paintings nor do you have to be a calculus nerd to apply risk management. This is the most important ingredient in all successful trading. It includes managing the risk of individual trades and managing the risk of entire portfolios. Oh yes, I love my charts and my shirts and my socks.

Every trader has their rules. But in the opinion of the great Ed Seykota, anyone risking more than 3% of his equity per trade is probably a gunslinger. 1% per trade looks like the best; neither does 1.5% or 2% per trade looks too bad. If you are risking too much, say 5% per trade. Your account can grow like weeds, but the losses may also be unbearable. Risk on a trade is simply the difference between the entry price and your stop loss; the amount of exposure you have on each trade.

These are what I do: (a) I use an order size of 0.01 lots for every $500 I risk. If it’s $1000, I use 0.02 lots, 0.04 lots for $2000, 0.1 lots for $5000, 0.2 lots for $10,000, 1.02 lots $51,000, 2.0 lots for $100,000, 20.0 lots for $1,000,000 and son on. (b) For every $500 I gain, I add 0.01 lots to my position sizes, and for every $500 I lose, I remove 0.01 lots from my trade sizes. (c) I choose only brokers that give me unique money management flexibility. (d) My stop loss is -75 pips and my take profit is +235 pips per trade – with high spreads considered. This could be modified soon! (e) I can place trades and go away. When I later check I’ll apply a minimum of 60-pip trailing stop, if I’ve gained up to 70 pips. And later adjust it to a minimum of 70-pip trailing stop if I’ve gained up to 100 pips. With this I try to ride the trend until the market goes to my target or reverses against me. Losing trades happen quickly. Winning trades take time to develop. I don’t apply the trailing stop if I don’t gain up to 70 pips, nor will I ever use a value below 60 pips. I’m a swing trader. I need to consider the market’s volatility if I’m using trailing stop. If a trade won’t move well in my favor, then let it hit my stop loss and get out of my sight!

That’s all I do. I got no special secret. I’ve found a way of disciplining myself to follow these simple rules. Trading is like entering a battlefield and preparing for the worst. If you have this mindset, you’ll not want to risk too much. So try to develop a risk management technique that fits you. Please let me conclude with more quotes from Dr Steenbarger:

1. ‘Most traders put their money at risk before they have developed the necessary knowledge and skills…’’

2. ‘My only saving grace is that I never forget that I’m a student of the market.’’

3. ‘You can’t win the game if you don’t stay in the game.’’

4. ‘I started making money only after I stopped losing it.’’