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Managing your risk effectively is one of the keys to becoming a regular profitable trader. If you lose half, in other words 50%, of your trading account, just remember that you need to earn 100% on the remainder to get back to where you started from.
Many expert traders consider that you should not risk losing more than 2% on any particular trade, nor put more than 20% of your trading account on one stock. This is based on the reasonable assumption that you could have as many as five losing trades in a row, losing 10% of your account, and you cannot afford for that to happen very often before you are in serious trouble.
Every time you consider a trade, you should have a clear idea of the amount you expect to make if it goes your way, and at what level you will exit quickly if it does not. These two numbers give you your risk/reward ratio, and most traders will not enter a trade unless this is at least 2 to 1 and preferably 3 to 1 (that is, you expect to make three times as much with a winning trade as you would lose if it went the wrong way). Some novice traders have no clear idea or expectation of how far the price may go up, and while you may hope for it to zoom to the skies, you can usually form a judgment of an expected target, perhaps using Fibonacci ratios.
There are two important sayings in trading. “Let the trend be your friend” and “Cut your losses and let your profits run.” Ignoring these two sayings is bound to lead to disappointment.
“Let the trend be your friend” urges you to trade with the price trend in place. While it is possible to make frequent small profits by trading within a range, which includes trading down (short) as well as up, the novice in particular should pay attention to the prevailing trend, and never trying to second-guess the market running against it. Remember that you are unlikely to spot the exact start or finish of a trend, but that does not matter. As long as you ride part of the trend, you will make your profit, and it is much more likely to succeed if you wait for a trend to start rather than guess at the point when the market will turn.
With a good trading system, you should not have a problem with cutting your losses, or letting your profits run. The fact that so many beginning traders find this difficult can be attributed to the power of emotion when the real money is at risk. If a trade does not start in the desired direction, then you must be ready to get out of it at a small loss. If you think it is hard to take a small loss so quickly, just think how much more difficult it is to leave the trade in place and have to take a much larger loss later.
On the other hand, and particularly after a losing trade, the inexperienced trader will rush to take profits on the next performing trade, rather than letting it fully blossom. Of course, he will have a gain, but it will not be the best he could do. Controlling the emotions is key to successful trading.
