One of the most popular discussions in trading forums is how much a trader should risk per trade. A lot of them go by the standard 1% to 2% while the more aggressive ones sometimes recommend risking as much as 5%.
What you need to understand is that taking risk is not a one-dimensional pursuit. Sure there are basic rules you follow, but it’s still more profitable in the long run to factor in your personal preferences.
Risk tolerance basically tells you how comfortable you are with possibly losing money in exchange for potential profits.
Those who have stable income or experience in financial markets tend to be more aggressive, while those who have other financial obligations and limited trading experience usually take the less risky road to profitability.
Unfortunately, this is not always the case for forex traders. Too many newbies are lured by the prospect of quick, easy profits and, because they have limited trading experience, they usually end up taking on more risk than they can handle.
The problem with risking more money than you’re comfortable with is that the prospect of losing will ruin your trading mindset and keep you from making the right trading decisions. You’ll end up basing your decisions on your account balance rather than your training.
For example, your demo trades show that you’re most profitable when you place your stops 100 pips away from your entry price. But because you’re not comfortable with the losses a 100-pip stop would entail, you close your losing trades at the earliest opportunity.You then bang your head on the table when price turns around and eventually goes your way. You might even take revenge trades and double up on your losses until you blow your account!
So how do you know how aggressive you should be with each trade? Here are a couple of considerations:
Do you have a stable income source? If you’re expecting regular paychecks, then you won’t mind a loss here and there and you can concentrate on your trading skills.
But if you expect your trading profits to become your only source of income or pay your debts and other financial obligations, then you’ll likely have tons of fear/greed-based decisions and should stick to smaller position sizes.
How much have you invested on your trading business? A larger trading account can survive bigger positions per trade. Consequently, traders who have small accounts shouldn’t trade standard or even mini lots that would trigger a margin call at the smallest volatility.
How long are you planning to keep your trade open? Position sizes are generally smaller for longer-term trades, as they need to withstand more volatility.
If you’ve been trading long enough, then you’ll have more confidence in your trading instincts and decisions.In fact, upping your position size might be your next step in improving your trading game. But if you’re new to the hood and you’re still making decisions based on emotions, then trading smaller position sizes might be a better option.
Remember that there’s no single formula for risk-taking. You can read different books and blogs and ask other traders in forums, but at the end of the day, how much you risk per trade depends on your own risk tolerance.
You can start with risking 1% of your account per trade and see how that works for you. Reduce it if you find yourself worrying about your balance instead of how well you execute your trading plan. Increase your average position size if you find that the potential gains aren’t motivating enough for you.
You may not see it, but your risk tolerance affects your every trading decision. Find a happy balance that would make significant enough changes in your account and enable you to focus on improving your trading skill at the same time and you’ll eventually find your way to consistent profitability.