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is $10,000. Because of uncontrollable risk factors, the amount of money you could lose would be generally less than $500 (5 percent), and only in extreme cases $1000 (10 percent). |
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If the combined risk (avoidable and unavoidable) is 10 percent or more, the trader is at extreme risk of losing all equity. This is because ten consecutive losing trades will eliminate all the trader's capital. Contrary to what many beginning traders think, there is a fairly good chance of this taking place. Very rarely are subsequent trades a totally independent event. In addition, markets that were seemingly uncorrelated could become positively or negatively correlated overnight and move against the trader. Consequently subjecting one's equity to a 10 percent risk of loss on a single trade is a very risky proposition. Likewise, risking only 5 percent of equity while removing the probability of losing all the equity by encountering 10 consecutive losing trades does not eliminate the possibility that 50 percent of equity could be lost. As previously mentioned, a 50 percent equity loss demands a 100 percent gain, making it quite likely that the trader will never recover. This is why most professional traders will risk only 1 to 4 percent of available equity on any one trade. It is my sincere recommendation that novice traders risk only .5 to 2 percent of equity on any one trade. The percentage of equity that is placed at risk is always based upon the currently available capital. |
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Risking less equity means that the equity growth will continue to increase, albeit at a slower rate. Risking more equity will increase equity growth at a faster rate or result in the total loss of equity! Remember that the average successful trader has a profit-to-loss ratio of 1.5 to 2.0, and 25 to 50 percent are profitable trades. |
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Your equity will increase or decrease on a day-to-day basis. It is of little comfort to be correct in your long-term view if all your money was lost in the short term. Consequently risking only a small percentage of equity on any one trade will protect your capital. For the most part, professional traders never risk more than 1 to 4 percent of available equity on any one trade. This is because of the ever-present possibility of that particular trade becoming a severe loss owing to uncontrollable risk factors, or a series of losing trades starting with that trade. Trading demands the trader work with and understand probabilities. Consequently professional traders will always understand the probable outcome of any trade. The possible reward must exceed the definite risk exposure of that trade. Professional traders enter into a trade only when the reward-to-risk ratio is in their favor. Professional traders fully understand that they are at the beginning of their equity curve at the start of each trading day. This is an important concept for all beginning traders to comprehend. |
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