Risk Management is the Cornerstone of a Trading Plan

A trading plan is one of the key elements of becoming a successful trader. Many new traders don’t have one and as a result they tend to act impulsively in the markets.

Think of a trading plan as a guide that will help keep you focused and disciplined. You have a far higher chance of being a profitable trader if you follow a clear set of trading rules that cover what you trade, when you trade and how you manage your risk and emotions.

If you don’t have a plan, you don’t have a process to follow and if you don’t have a process to follow you can’t identify what you may be doing wrong and adapt your behaviour so you can improve.

Many traders are unaware that 80% of their success in this game will be down to how they manage their risk and emotions with only 20% down to their approach and system.

So, let’s start with risk management and why this is the cornerstone of you’re a trading plan.

Risk Management

If you’re a new trader with a small account (less than $1000) you need to think in percentages as opposed to monetary returns.

What do I mean? Say for example you achieved a return of 2% on one trade and only risked 1% of your account to achieve this (a 2-to-1 reward risk.) that would be considered excellent risk management.

Here lies the problem; it’s difficult for traders to think like this when 2% of $1,000 (being $20) is seen by many as too small a financial return to be a considered a good trade.

The same traders are looking to make $200 on a trade and are prepared to risk $100-$200 to achieve this.

What happens in this scenario is that the same trader gets a handful of trades wrong and all of a sudden, they have a big hole in their trading account as a result of the risk they have taken.

What if the same beginner, traded their account like it was a $1million dollar account? A 2% return on one trade on this size of account becomes $20,000 which now looks like an incredible return.

 Would that same trader with such an account size risk $100,000 – $200,000 on one trade? Highly unlikely. So, why do it with a $1,000 account?

Professional trader’s always think in percentages. On every trade a pro asks themselves “what percentage of my account am I risking on this trade versus the percentage expectation on return?”.

Your position size and the risk you take must correlate to your current account size. Don’t try to be a hero and take a level of risk that your account size can’t handle, or you will hit a wall of frustration and disappointment.

Having a maximum risk per trade and a maximum pain threshold that you are prepared to take on any given day or week is what all professionals do.

 When the pro hits their max risk level they shut down finish for the day and come back the next day with a clear head and new perspective.

Remember there are always great opportunities in the market, how can you take advantage of these when you have no money left in your trading account?

Emotional Roller Coaster

A risk management plan will help prevent you going on an emotional roller coaster.

If you don’t have a risk plan and you get lucky you will likely end up suffering from “hero syndrome” and you will start increasing your trade sizes and the frequency of your trades, taking more risk in the process.

If you don’t get lucky you will likely start chasing your losses and end up taking bigger positions, more risk and increase the frequency of your trade which will not end well.

A risk plan is there to stop you getting emotional, all you got to do, is stick to your risk rules and you will give yourself the best chance of succeeding.

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