Risk Management

The practice of actively protecting your money as you trade. Risk management typically manifests as a set of rules or guidelines to protect against large losses.

Why it matters

In order to succeed you must first survive
- Warren Buffett

Risk management is arguably the most important aspect of trading. Imagine you start with 100 dollars, take a few trades and end up losing 50. You lost 50% of your capital, but now need a 100% return to get back to where you started.

This effect is exponential, the larger the loss, the harder it is to recover. Protecting your capital from the start is key to exponential growth, rather then exponential loss.

How to manage risk effectively

1. Position Sizing - Determine how much of your account you are willing to risk per trade. Generally, never more than 1-2% of your account per trade. Many professional traders risk less than 1%.
2. Use a Stop-loss - The size (or cost) of a trade is your risk tolerance. Stop-losses can slip. In risk management, you should always assume the worst, and thus never enter with more than you are willing to lose.