One of the main pillars of trading is managing your risk. To put it bluntly, it’s a significant aspect of being a competent trader. The fundamental principle is to know your potential loss and gain, along with the probability of a favorable outcome. This is what trading is all about.
To become a professional trader, you need to master risk management, period. Managing your risk-to-reward ratio is also crucial for long-term success, which helps you keep your emotions in check. Any deviations from your trading system or rules that resulted in significant losses will stand out and occur less frequently.
Personally, I’ve built entire strategies and trade setups around the concept of risk. If I know where my stop loss will be, I can determine where my entry point should be. Ideally, the entry point should be as close to the stop loss as possible. A basic risk-versus-reward trade plan involves positioning yourself close to the stop loss, risking the least amount of money, and aiming for a much higher reward.
For instance, if you want to trade a stock that’s bouncing off the $19 area and hitting the psychological area of $22, you should enter as close to the stop loss area as possible, risking the least amount of money while aiming for a higher reward. If your stop loss is at $18.80, you could position yourself near that stop by buying in at $19.20, thereby risking only $0.40. Your first goal would be at the hard resistance area of $22, which makes your initial risk-to-reward ratio 0.40:2.80.
If you lose two or three such setups in a row, keep at it until you find a winning trade that covers your losses and puts you back in the green. By sticking to your system and rules and keeping your emotions under control, you’ll be okay. Essentially, you’re the casino, and the odds are in your favor.
It’s crucial to execute such setups with a lot of forethought and do your due diligence on the trade. I usually create my trade plan based on support and resistance levels. Jumping in near support and aiming for resistance is the ideal strategy.
In conclusion, if you strictly adhere to your risk-to-reward ratio, you won’t ever blow up an account. Only unforeseeable events and extreme losses will shake you. You should monitor and study any large uncharacteristic losses, but as long as you stick to your trading style and incorporate risk-to-reward management, you’ll be consistent and professional. Make risk management an integral part of your trading strategy, and you’ll become a better trader.
