Know your loss before you start:managing risk is the larger part.
The process of identifying, assessing and controlling potential trading losses through position sizing, stop losses and diversification, and by limiting the loss planned on any one trade.
A commonly quoted convention puts that limit at 1% to 2% of account equity; these measures limit planned losses and do not remove risk.
In plain words
Risk management is deciding, before a trade is opened, how much could be lost and taking steps to keep that amount within a chosen limit. The main tools are the size of the position, an order that closes it at a set loss (a stop loss), and not having every position depend on the same market move.
See it move
Risk management and Position size
Why it matters
With leverage a position can be far larger than the money in the account, so losses can build quickly. A common convention is to limit the loss planned on any one trade to a small percentage of the account, often quoted as 1% or 2%.
Worked example
An example only. The figures are round and invented for the arithmetic: they are not market prices.
A trader with a 10,000 US dollar account chooses to risk 1% on a EUR/USD trade whose stop loss is 50 pips from the entry.
- 1Amount at risk1% of 10,000 = 100 US dollars.
- 2Value per pip that fits100 ÷ 50 pips = 2 US dollars a pip.
- 3One standard lot is worth 10 US dollars a pip, so 2 US dollars a pip is 0.2 lots.
At 0.2 lots a 50 pip loss is 100 US dollars, which is 1% of the account, provided the stop is filled at its price.
A common mistake
Risk management limits planned losses; it does not remove risk. A stop loss can be filled at a worse price when the market gaps or moves fast, so the actual loss can exceed the planned one.
Check yourself
Learn more
- Academy lessonThe risk-reward ratioHow the risk-reward ratio and expectancy are calculated, the break-even win rate each ratio implies, and the mistakes that quietly change the ratio.
- Academy lessonPosition sizingLot sizes, the percent-risk model, fixed-fractional sizing and the Kelly criterion, with the formulae and a worked example.
- GuideFive risk management rules for leveraged tradingRisk per trade, stop placement, the reward-to-risk arithmetic, correlated exposure and a written plan: five habits that limit how much a single mistake can cost.
- GuidePosition sizing: the arithmetic of risk per tradeFixed percentage, fixed amount, Kelly and volatility-based sizing, with the formula and a worked example for each.
Educational information, not investment advice or a recommendation to trade.