The Name of the Game is Risk Management
Hello, traders. Welcome to the Pro Trading Course and the second module, A Pro Trader’s Mindset. In this lesson we are looking at the name of the game, and the name of the game is risk management. Well, the recent name of the game is risk management is because a pro trader will focus on capital preservation rather than what price is actually going to do.
So let’s start by defining what risk management is. No one knows where the market is going to go or where it’s going to be in two days. No one has a crystal ball to find out, and anyone who tells you the opposite is lying to you. Being a professional trader is not about knowing the future direction in price.
It’s actually about capital preservation and risk management. And the reason is because no one knows if price is going to bounce off a level of or if price is going to break a level. So what you need to focus on is your risk management and your trade setups. Trading like a professional is not about hitting 1,000 pip home runs every time, but about consistently winning and keeping your losses small.
And this is very important because novice traders will actually look to hit those home runs every single time, and they will get into trade trying and hoping that price moves that many pips in their favors, not looking at the most important part of the setup, which is the risk to reward ratio and the exit levels.
Everything has to do with the appropriate risk management and position sizing. The rule of thumb is not to risk more than 2% of your equity and only trade setups with a one to two risk to reward ratio or higher. I myself trade a one to three risk to reward ratio or higher on my setup. If a setup doesn’t yield at least a one to three, I will not trade it. And I’m going to show you why the risk to reward ratio on your setup is so important.
But first of all let’s look at an example. Making money doesn’t come down to a single trade but to a series of trades. Now let’s assume that we are looking at price action at this level right here. So you may think that because price has hit this area of resistance, it might be a good time to short this instrument.
So you go short and you put your stock loss above the previous high. What happens is that price moves in your favor, but then it hits your stop loss, taking you out on an 11-pip loss. This is not important. Well, it is important because you lost the trade, but because you are a professional trader you are going to keep your head cool and just wait for the next setup.
Now price comes all the way up to this level and comes down again to these previous highs. So you assume that, well, you don’t assume you, analyze price action and see that this is a great spot to go long. So you go long right here with a stop loss below the previous low, which is the appropriate stop loss position.
And what happens is that the price moves in your favor but then drops and hits your stop loss, taking you out on a 24-pip stop or a 24-pip loss. So by this time you are down 35 pips for the day. But because you follow correct money management rules, this doesn’t bother you too much and you continue to look for the next setup.
Then price comes all the way up here in a very choppy market where there is no setup at all, and the price comes down to this zone of support and you decide to go long right here with a stop loss below the previous low, all right? So what you’re doing here is you’re following price structures and following your money and risk management rules.
And what happens here is that price comes all the way up here for a 109-pip win, which means that now you are 74 pips positive for the day. So you see that making money doesn’t come down to a single trade but to a series of trades. And by utilizing appropriate money management and risk management rules, you are going to be making money in the long run.
Now, this is just an example of how the trades would look on this particular day. Let’s go and take a look at the capital preservation that I wanted the risk to reward ratio yields. Now, this is very simple. You start with 100,000 equity and a 2% risk rule, all right? So let’s say that you lost the first two trades of the day. You lost $2,000 on the first trade, bumping down your equity to $98,000.
Then your risk, 2%, or $1,960, and you lost that, too. So your equity now is down to $96,040. But you go ahead and have a new setup for the day. You risk 2% percent of $1,920 and you win that trade. Because it has a one to two risk to reward ratio, you are risking $1,920 to win $3,841. You win that trade, your equity bumps to almost break even in one single trade.
Then you have a new set up, which you will you risk 2%, which you win, and that bumps your equity to $103,876. So you see with the two wins and…well, with two losses and two wins with a one to two risk to reward ratio and a 2% risk rule, you are almost 4% for the day on your account. And then you win the next trade and you are up 8%, all right?
Let’s say that you lose your sixth trade, risking 2% on a $108,000 equity. You are down now to $105,871 on your equity and you have the last setup for the day on which you will risk 2% and you win it. And because you have a 1 to 2% ratio, risk to reward ratio, you are going to make twice the amount of money that you risk on a winning trade.
So you end up after seven trades with an equity of $110,100, which means that after seven trades and three losses and four wins, you are up 10 % on your account. So you see that if you choose to only trade one to three risk to reward ratio scenarios or one to three risk to reward ratio or setups, your account would be even higher or your equity would be even higher. B
Because when you lose, you lose 2%, but when you win, you win three times what you were risking. So that’s why it’s important for you to have very strict money management rules and very strict risk rules when it comes to trading. And professional traders do this all of the time. They don’t focus on whether they’re right or wrong or whether price is going to go in their favor or not because no one knows what price is going to do. What they focus is on risk management and trading high probability set ups with strict risk parameters.