Knowing Your Limits
Trading in general, but particularly in the Forex market, requires that you have solid psychology when it comes to risk and loss.
A lot of new traders come to make boatloads of money sure, but nobody ever says “hey! while you’re making all that money, you’re gonna be losing some in the process”.
And no the losing doesn’t stop once you become a good trader, taking losses in trading is just part of doing business! You take trades because some or most of those trades will be profitable, but that means there will be losses in that process.
So when I talk about limits… I mean can you withstand a drawdown? How much money can you lose, before you stop trading your plan and your emotions have taken over?
To clarify my previous question. How many trades can you lose in a row before your emotions are shot and your trading plan goes out of the window? I’m willing to bet that the number that will get you shaken up, depends on your risk.
How much are you risking per trade? Are you risking $1 per trade on a $100 account? Or are you risking $20 on a $100?
Losing 3 trades in a row while risking a dollar is easy. You don’t even blink! But losing $20 when you can’t afford to lose that $100, is another nightmare completely. If the whole $100 is worthless to you, then maybe you could manage.
But if it $1000? How about $10000? Would you be okay with losing 3 trades and in a row when you risked $2000 per trade? I doubt it.
This goes back to something I said in my previous article about “flipping” accounts. It is much easier to take on more risk when you trade with money you can afford to lose.
If you already cannot afford to lose the money you’re trading with, you are at a disadvantage because you will be less equipped (mentally) to cope with a drawdown vs. the guy who doesn’t need that money.
For you, 3 or 4 losses in a row could completely wreck you emotionally and it is much harder to trade profitably when you NEED that next trade to be a winner.
It’s what causes shy traders and makes it hard to pull the trigger, or what pushes you to revenge trade. The NEED to win A PARTICULAR trade.
The moment you recognize yourself putting all your hopes on ONE trade. Rsk less on that position. Yes, bills need to be paid! And yes, you need to become a great trader! But if you put pressure on the outcome of any 1 trade, neither of those things are going to happen.
How do I find the limit?
But how do you find your limit? Your emotions shouldn’t be the one to tell you. You should study your system and find your average win rate (roughly the percentage of trades you expect to win out of 10 or 100 or 1000).
Does your system win roughly 30% of its trades? Roughly 50%? Maybe you have a high win rate of 70% ? With these different percentages, you can roughly estimate how likely it is for you to lose a couple of trades in a row.
If your win rate is 30% you cannot be risking 5-10% on your trades! Why? Because if you take 10 trades, chances are you will win 3 of them and they will pay for the losses.
But if the first 5 trades are losers, you could lose half your account! And at that point, you need to make a 100% return to get back to break even.
Experimenting with something called your risk of ruin can give you an estimate of a “mechanical” limit (a limit that, if broken, will guarantee the blowing of your account).
Your “soft” limit (a limit of losses YOU can take before you shut down mentally and your emotions take control of your decisions) can be exercised and practiced.
This will be your saving grace because if you encounter a drawdown, you need to push on and continue to execute those trades as if you haven’t lost a single trade yet. This is where your soft limit comes into play.
Truth is, most of us won’t have a 80% win rate, so we can expect losing streaks fairly often. To be profitable in the long run, we have to be able to withstand those losing streaks and keep trading consistently.
If you don’t keep at it, you will miss the winning trades you’ve been waiting for. Winning trades that can pay for those losses and then some, which makes you even more emotional and you start going further away from your trading plan (start chasing wins).
Don’t do that. Exercise sticking to your plan and trading through those drawdowns (IF YOU HAVE PROFITABLE STRATEGY)!
Don’t bet the farm
Don’t lose your shirt
Cut the L
Keep the W
Risk per trade FAQ
A percentage of total capital allocated to a position.
The percentage limit that you are allowed to risk per position i.e. you cannot place a trade that would exceed this value.
1-2% per position is a good guideline, but don’t go over. With a $10000 trading account, this would mean a max risk of $200 per trade. With a $50000 trading account, this would mean a max risk of $1000 per trade.