Less Is Better – How I Determine Risk in a Trade

By | September 1, 2014

I consider risk control to be the most important aspect in trading. A lot of people might disagree with that, but I know that successful traders who’ve been at it for decades share my view.

The most important rule of trading is to play great defense, not great offense. – Paul Tudor Jones

The most advocated risk per trade in the forex world is 2% of the account. That’s preached as being ‘conservative’ by educators masquerading as traders. Complete novices who start with $500 or $1k hoping to make $20k in a year will obviously risk much more than that. After they waste their account, they’ll begin listening to the educators talking about the 2%, and think that sounds more reasonable than 10% or 15%. They will also see how many students these educators have and will say to themselves: So many people can’t be mistaken, right ? Wrong !

Trade for a long enough period of time and that ‘conservative’ 2% will get you into draw-downs of 30% plus which most likely will make you abandon trading with a wounded ego, not to mention your bank account. Now I can almost hear the ‘smart’ ones among you saying: 15 losses in a row ? My system is much better than that, my back-testing shows only 5 losses in a row, bla bla. I’ll just say this: If you don’t believe you’ll have 20 trades in a row not necessarily all losses but mixed with break-evens and with next to nothing profits, you’ve not traded for long enough.

As I said in the title, I believe that less risk is better. Consequently, I don’t risk more than 0.5%  of equity (yes, you read that right, it’s half of 1%) per trade. I go even lower than that (0,3% – 0,4%) when I’m in a prolonged draw-down. That certainly sounds appealing, to be down only 2% after 4 losing trades. But the big question I hear you ask is: ‘Can we have any significant upside when trading such small percentages of equity ?’. Yes, we can. And I get that upside by pyramiding the profits on trades that go my way. I don’t close a trade just because I’m up 1,5% on it. (the ‘magical’ 1:3 ratio).

I just scratched the surface of  risk control aspect with this article. What I hope to achieve is to get you to challenge in your mind the notion that 2% is the optimal risk percentage.