Know Your Risk

Risk control is always at the forefront of a professional traders mind. It is disciplined risk control which keeps a trader in the game long enough to become a truly great trader. Amateur traders on the other hand focus solely on profit potential ahead of risk control which leads to bad habits fuelled by greed. As a trader you must be aware of what your risk level in the market is at any one time and if you don’t know the answer to that question then actually, you’re the risk! 

At Trade with Precision we recommend to our clients that they risk a maximum of 1% of their trading capital on any one trade. Trading at such a low risk level ensures clients don’t lose allot of their money (assuming they follow these suggestions) when they are learning to trade as more often than not when a client starts out trading they are likely to go through a period of drawdown. The trick with this drawdown period is to make sure it’s short and shallow. What you must ensure you get right in order to control your risk is your position size. To work out your position size you will first need to know what level your entry should be at, along with what level your stop loss will be at. Once you have these two numbers you can then use them to figure out what your position size should be in order to have 1% of your trading capital at risk.   

Let’s run through a quick example to help you understand how to calculate your risk level properly. Say you are looking to buy EURUSD @ 1.0750 and you have worked out that your stop loss should be at 1.0700. Your account balance is $10,000 therefore your maximum risk is $100 on any one trade. The difference between your entry and stop loss is 50 pips and your broker platform shows a pip cost per single contract at 0.15. If you start increasing the quantity of contracts for your position size until you reach a pip cost of 2.00 per pip you will reach your maximum risk level for that trade (as 2.00 per pip x 50 pip stop loss = $100 at risk). These days the broker platform usually makes it easy for you as it calculates the amount of cash you have at risk on a trade if you input your entry and stop loss into the order ticket.

We must also be well aware of any news events that may add risk to our open positions. We recommend that traders only enter into a trade if there isn’t what we call “3 bull” news coming out (relating to the product traded) within 4 hours of entering into a position. The chart below which you can find on our website here lists all the relevant news events coming out throughout the week. As you can see each news item is ranked with 1, 2 or 3 bulls depending on projected market impact with 3 bulls being at the larger impact end of the scale.

The graph shows that there is 3 bull news coming out in Australia in less than 4 hours. Looking at this from a risk point of view we would not be looking to enter into a trade involving the Aussie dollar in the next four hours as the news event increases the risk of the Aussie dollar becoming volatile during that period which means our possibility of getting stopped out has increased.

These are just a few tools which we use to control risk as we want risk to be at the forefront of our minds when trading. When you next enter into a trade, ask yourself whether you’re more focused on the profit aspect of the trade or the risk aspect? Your answer will reveal some interesting insights into your trading mindset.

Happy Trading!

The TWP Team