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Risk Management And Risk Reward Ratio Rules

Risk management rules and risk reward ratio for day trading
One of the most important topics you need to understand when trading is risk management.

It doesn't matter if you do swing trading, day trading, scaling or binary trading - risk management is key.

Specifically how to control risk and the importance of a good risk reward ratio. 

You need to focus on doing what you can to reduce the size of your losses when they happen.

When trading on a margin account you can easily lose all your money if a trade goes against you and your position size is too big for your account.

At the same time, you also need to optimize your trade size to make the biggest possible profit according to your risk preference on each trade. 

By knowing how to manage risks you can play the long game and start making consistent profits.
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Risk Management Quotes

“Don’t focus on making money; focus on protecting what you have.” Paul Tudor Jones
“Risk comes from not knowing what you’re doing.” Warren Buffett
“Frankly, I don’t see markets; I see risks, rewards, and money.”- Larry Hite

Risk Management Basics

Anything can happen in the markets.

And anything can affect the price of a stock, forex pair or commodity in a negative or a positive way. 

So instead of 'going all in' (most often results in blown accounts) like most beginners do,  it's better to manage your risk, because if you lose, you will still be able take the next trade.

"Going all in" is very common mistake, especially amongst beginner traders just starting out.

The two most important rules of risk management is:

1. You should never risk more than you can afford to lose. 

2- You should always trade with a good Risk Reward Ratio (RRR).

What Is Risk Reward Ratio RRR?

Your risk reward ratio is how much you risk per trade, relative to how much expect to make (reward). 

When trading you should always aim for a bigger reward compared to your risk per trade.

Let's look at an example...

A good rule is to only risk 1% per trade (the 1% rule).

Following this rule means you will not risk losing more than 1% of your account value on a single trade. 

Important - a common misunderstanding is thinking you can only use 1% of your account to trade with, but 1% rule does not mean that if you have a $10,000 trading account, that you can only take a $100 position, which is 1% of $10,000.

You can use all of your capital on a single trade, or even more if you utilize leverage (if done correctly).

Calculating Risk Reward Ratio RRR

What I mean by using the 1% risk rule is that you apply risk management to avoid a losing more than 1% of your trading account value on a single trade. 

So if you lose a trade with your $10,000 trading account, your account value will be $9,900.

In trading, it's impossible to win every trade, and the 1% risk rule helps protect your account when you lose. If you risk 1 percent of your trading account on each trade, it doesn't hurt you to lose 5 trades in a row. 

If more beginner traders followed the 1% rule, many more would be successfully their first year trading.

Risking 1% per trade may seem like a small amount to some people, but it can still provide great returns by trading with a good risk reward ratio.

If you risk 1 percent, you should preferably set your take profit to 2 percent or more. 

Risk reward ratio 2/1 = 2.

When swing or day trading, gaining a few percentage points on your account each day is possible when using this simple rule, even if you only win half of your trades.

How To Manage Risk In Trading

Forex traders can avail several methods to avoid loss from unwanted common mistakes. There needs to be in place a proper strategy and prove trading plan. It should include all details pertaining to risk management. Also, it is to be something practical and easy to follow. According to experts, it is wise to focus upon higher probability trades. A good amount of risk prevails in this industry. Hence, it is not necessarily the very best discipline meant for all investors. Moreover, extra attention needs to be paid to avoid the commonly committed mistakes and to engage in trading activities. The effort and time spent to come up with a trading plan is considered to be a wonderful investment. It can help to enjoy a profitable and rewarding future.

Common Risk Management Mistakes

A fundamental rule to follow Forex market risk management is to not risk much more than what can be afforded. But this is found to be a commonly committed mistake mostly by amateurs and new entrants. Being a highly unpredictable market, the traders eager to invest more are likely to get vulnerable to the risks faced in the market. The Forex market is prone to be affected by just about anything. It can even be a small piece of news, which is likely to affect the rates of any specific currency in positive or negative way. It will be useful and wise to trade in conservative amounts of capital and follow moderate path.

Best Risk Reward Ratio For Trading

Without having solid and realistic forex risk management strategies in place, the chances of losing out everything are very high. Risk management, according to the experts, are actually ideas helping to reduce losses and to optimize protection to investors. It can include limiting trade lot size, trading during certain days or hours only, hedging and to recognize the right time to take losses. These measures however, are not implemented by majority of the traders, as they make risky investments by using leverage. But many are not able to succeed in the long run with their execution, since the risks of losing all is more. As a responsible trader, you need to undertake adequate precautions.

How To Build A Risk Management Strategy

A powerful and effective risk control strategy is to know when to cut on losses, which can be achieved with ‘hard stop’. In this method, a well known trading platform technology is used to lock the stop loss at specific level. It can also be achieved with ‘mental stop’, where you need to determine the drawdown limit on the trade and to exit at certain point. 

While it is good to make use of reduced lot size, trying to open up multiple lots using currency pairs is likely to cripple you. If you go long on CHF/USD and short on USD/EUR, then you are likely to get exposed over two times to USD. In case, USD tumbles, then you are likely to suffer from double loss. However by limiting overall exposure can help reduce risks and to increase long term prospects. By limiting risks, you will be in a position to be in the game and to enjoy trading, even during turbulent times.
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Johan Nordstrom Professional Trader Risk Management
I'm a family guy in my early 30's who learned how to trade the markets in a simple yet effective way. During university I studied investing and graduated with a master's degree in risk management. Quickly, I realized that I was onto something. I started helping friends and taking students. My students started getting results, spent less time in front of their screens, and their accounts grew consistently. Learn more about me here.
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