How much should you risk per trade when trading? This is a question that every trader must answer for themselves, as there is no definitive answer. The amount of risk you take on each trade should be based on your own personal risk tolerance and trading goals. In this blog post, we’ll discuss some factors to consider when deciding how much risk to take on per trade and show you a few scenarios.
Define Your Risk Tolerance
How much are you willing to lose per trade without it affecting your overall trading strategy?
When it comes to trading, having a clear understanding of your risk tolerance level is essential for success. Knowing the amount of money you are willing to lose per trade can help guide your trading decisions and ensure that you do not overextend yourself.
Many trading experts recommend, as a rule of thumb, that traders risk around 2% of their account balance per trade. That can be toggled to your threshold, but be aware that risking a significant portion of your balance on trades can have drastic results.
Sure, you’ll make more profit when the trades are going your way, but the drawdown consequences are similarly amplified if you have a string of bad trades. Keeping a handle on how much you are willing to lose can foster sustainable growth and allow for consistent returns. If taken seriously, dieting down your risk tolerance level can prevent painful losses and give clarity when navigating the markets.
For instance, if you identify that you want to risk 10% of your total capital on each trade, the drawdown implications are extremely dangerous to your bankroll.
Scenario: Risking 2% vs. 10% on Each Trade
Take a look at the following scenarios. In each, you start with a $100,000 balance and have a string of twenty bad trades — which is a lot, but good for this comparison. The only difference between the two scenarios is that in one, you risk 2% of your balance on each trade and, in the other, you risk 10% of your balance on each trade.
The Result
You can see how losses are amplified by risking 10% instead of 2% of your account balance on each trade.
Risking 10% per trade.
If you had a bad losing streak of twenty trades in a row, you’d only have $13,509 left of your $100,000 starting balance — an 86% drawdown.
Risking 2% per trade
On the other hand, by risking only 2% of your balance on each trade, you’d still have $68,123 left of your $100,000 starting balance — a 32% drawdown.
Of course, no one plans to lose twenty times in a row, but what if it was only five trades in a row?
At 2% per trade, you’d still have around $92,000 in your account.
At 10% per trade, you’d have about $65,000 in your account — which is less than if you’d lost all twenty trades risking 2%.
That’s a huge difference. The moral of the story is that you want your risk management rules constructed in a way that, if you do suffer a drawdown, you’ll still have sufficient capital to weather the storm and stay in the game.
Getting Back to Breakeven
So, let’s carry through the previous example of risking 2% vs. 10% of your account balance on each trade.
If you had risked 10% per trade and drawn down 86% of your account, how much would you have to make to get back to breakeven?
The answer: is about 570%.
Astounding. By suffering huge losses in risking too much on each trade, the hill you have to climb to get back to breakeven gets bigger and bigger, because you have less capital to play the markets with. Again, the net effect of risking too much is amplified.
Take a look at this table to determine what percentage you would have to make to get back to breakeven if you were to lose a certain percentage of your account.
As you can see, the more you lose, the more difficult it is to get back to your original account balance — which is exactly why you should take proactive risk management steps to protect your trading account capital.
Consider the Potential Reward of Each Trade
In figuring out how much you are going to risk on each trade, ultimately, you have to ask yourself: Is the potential profit worth the risk?
Before engaging in any trade, it is essential to consider the potential reward. This includes analyzing potential profits and weighing them against the associated risks. After all, no one wants to leave money on the table when taking advantage of a trading opportunity; however, how much risk you are willing or able to take should be evaluated carefully.
Every trader needs to ask themselves if the benefits of a particular trade outweigh any potential downsides and make an informed decision based on these criteria. With experience and good judgment, anyone can make smart decisions that maximize their rewards while minimizing their losses.
Leave a reply