What is risk management in trading?

The set of limits a trader fixes before trading: how much one trade may lose, where it is closed if wrong, how much one day may lose, and how large a fall in the account is tolerable. Position size, stop loss, a daily limit and attention to drawdown are its ordinary tools. It limits losses; it does not make a method profitable.

How do risk per trade, drawdown and risk of ruin fit together?

Risk per trade is the share of the account one losing trade removes. A run of losing trades compounds into a drawdown, whose depth depends on that share and the length of the run. Risk of ruin is the chance that a drawdown ever reaches a level from which the account does not recover, and it depends on the win rate, the size of a win beside a loss, and the share risked.

Does this page say how much I should risk?

No. The 1% used in the illustration is a round figure chosen to make the arithmetic easy to follow. What a person can afford to lose depends on their circumstances, and this site gives no advice on it.

Trading · risk before reward

Risk management

Everything this site has on risk, in the order the questions arise: what one trade may lose, what one day may lose, how far a run of losses takes an account down, and the chance that it does not come back. Arithmetic you can check, and no advice on what your own limits should be.

The four questions Risk Disclosure

The spine

Four questions, each inside the next.

A trade sits inside a day, a day inside a run of days, and a run inside the life of the account. A limit set at one level is what keeps the next from being reached.

01
Per trade
What may this one trade lose?
The first limit is set before the trade is opened: a sum the account can lose on it, and the price at which the idea is wrong. The size of the position follows from those two, and is not chosen first.
The sum
10,000 × 1% = 100 at risk
100 ÷ (25 pips × 10 a pip) = 0.40 lots
02
Per day
What may this one day lose?
Trades come in runs, and judgement is at its worst after a few losses. A limit for the day, written beforehand, ends the session before a bad morning becomes a bad month. It can be a sum, a number of losing trades, or a time.
The sum
3 losses × 100 = 300
300 ÷ 10,000 = 3% of the account
03
Drawdown
How far down can a run take the account?
A drawdown is the fall from a high point of the account to the low that follows. Losses compound downwards, and the gain needed to recover is larger than the loss was, increasingly so as the loss deepens.
The sum
10 losses of 1% leave 90.4%
to return: a gain of 10.6%
04
Ruin
What is the chance it never comes back?
Ruin is a drawdown deep enough that the account, or the person, stops. Its likelihood depends on three things together: how often the method wins, how large a win is beside a loss, and the share risked each time. The first three steps are what keep the fourth small.
What it turns on
expectancy = win rate × average win − loss rate × average loss
the share risked decides how many losses the account can take

Illustration on one invented account of 10,000 with a stop 25 pips away on an instrument where one pip on one lot is worth 10. The 1% is a round figure for the arithmetic, not a recommendation, and none of these numbers is a market price or a GIO4X condition.

Why size comes first

Ten losses in a row, at four sizes.

A run of ten losses is rare in a short series of trades and far from impossible in a long one. The run is the same in every row; only the share risked on each trade changes. What is left falls faster than the share rises, and the way back grows faster still.

The sum is one line: what is left after n losses of a share r is (1 − r) multiplied by itself n times, and the gain needed to return is 1 ÷ that, less 1. The Drawdown tool and the Risk Room run it on figures of your own.

An account after ten losing trades in a row at four shares risked per trade: the share of the account left, and the gain needed to return to the start
Risked each trade	Left after 10 losses	Gain to return
1%	90.4%	10.6%
2%	81.7%	22.4%
5%	59.9%	67.0%
10%	34.9%	186.8%

Worked exampleArithmetic only. It assumes every loss is exactly the planned share, which a gap or slippage can exceed.

The other limit

Margin and leverage.

The four questions above are limits a trader sets. Margin is a limit the provider applies. A leveraged position ties up part of the account as margin; when losses reduce what remains to a stated share of that margin, the provider warns, and at a lower share it closes positions without asking. Those two points are the margin call and the stop out.

Leverage does not change which way a price moves. It changes how much of the account a given move is worth, and so how near the stop out stands. A position sized from the first question, with a stop, will usually be closed by the trader’s own rule long before the provider’s; a position sized from the leverage available will not.

The levels that apply to an account are a provider’s published terms, not a matter of arithmetic. GIO4X’s are on the Trading Conditions page as indicative figures, and the Risk Disclosure is the document that states the risks of trading on margin.

Work it through

The kit

What the site has, by kind.

Calculators

Rooms and records

Reading

The words, in the glossary

What this page does not do

Say what share of an account you should risk, where a stop belongs or how much leverage to use. Those depend on your circumstances and are yours to set.
Make a method profitable. Limits decide how long an account lasts and how fair a test the method gets; they give it no edge.
Remove the risk of trading on margin. A stop can be filled at a worse price than the one set when a market gaps, and a loss can then be larger than planned.
Replace the legal Risk Disclosure, which is a separate document.

Read the Risk Disclosure

Questions people ask

What is risk management in trading?: The set of limits a trader fixes before trading: how much one trade may lose, where it is closed if wrong, how much one day may lose, and how large a fall in the account is tolerable. Position size, stop loss, a daily limit and attention to drawdown are its ordinary tools. It limits losses; it does not make a method profitable.
How do risk per trade, drawdown and risk of ruin fit together?: Risk per trade is the share of the account one losing trade removes. A run of losing trades compounds into a drawdown, whose depth depends on that share and the length of the run. Risk of ruin is the chance that a drawdown ever reaches a level from which the account does not recover, and it depends on the win rate, the size of a win beside a loss, and the share risked.
Does this page say how much I should risk?: No. The 1% used in the illustration is a round figure chosen to make the arithmetic easy to follow. What a person can afford to lose depends on their circumstances, and this site gives no advice on it.

Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. Educational information, not investment advice or a recommendation to trade.

Continue

Fetching the page

Four questions, each inside the next.

Per trade

Per day

Drawdown

Ruin

Ten losses in a row, at four sizes.

Margin and leverage.

Work it through

What the site has, by kind.

Calculators

Rooms and records

Reading

The words, in the glossary

What this page does not do

Questions people ask

Four questions, each inside the next.

Per trade

Per day

Drawdown

Ruin

Ten losses in a row, at four sizes.

Margin and leverage.

Work it through

What the site has, by kind.

Calculators

Rooms and records

Reading

The words, in the glossary

What this page does not do

Questions people ask