Risk Management

Risk management in trading means risking only a defined amount of the total capital on each trade. There is no fixed formula or rule that can simply be applied mechanically. Instead, every trader has to work out over time with what amount and position size they enter a trade and still feel comfortable. Risk management is closely linked to money management, which sets the overall framework for the use of capital.

Adjusting the risk

Risk management is not rigid. In favourable market phases with stable trends, the risk per trade can be increased. In difficult market phases or after several losing trades in a row, the risk can be reduced by adjusting the position size in order to protect the capital.

Single-position risk and total risk

An important distinction is between the risk of an individual position and the total risk of all open positions. Several positions that each look small can add up to a considerable total risk – especially if they are in closely related markets that tend to move in the same direction.

Example: a trader with an account of $20,000 limits the risk per trade to 1% ($200) and the total risk of all open positions to 5% ($1,000). This allows a maximum of five positions with full risk at the same time. After a series of losses, the trader halves the risk per trade to $100 until market conditions improve.

Why it matters for traders

In leveraged forex and CFD trading, losses can mount quickly. Stop-losses, position sizing and a careful use of margin are therefore central tools of risk management, and diversification can help to spread risk. Good risk management cannot prevent losing trades, but it can keep them small enough that a losing streak does not turn into a drawdown that threatens the account.