Entering a trade marks the beginning of a delicate dance between risk and reward.
To succeed as a trader, risk management must take center stage in your strategy.
While no trading approach guarantees a 100% win rate, aligning your approach to ensure that wins significantly outweigh losses is the key to tipping the odds in your favor.
The Importance of Knowing Your Risk
Always enter a trade with a clear understanding of the potential risks involved.
Set a predetermined loss threshold, typically ranging from 10% to 20% depending on your trade size.
Whether it’s the amount of capital you’ve invested or a key chart level, defining your risk before entering a trade is paramount.
Using Stop Losses Strategically
1. Moving Stops
Place your initial stop behind support or resistance. If the trade invalidates by breaking key support/resistance, be ready to stop out.
Once your trade is up by 10% to 20%, adjust your stop to break even to safeguard against turning a profitable trade into a loss.
As gains reach 20% to 30%, move your stop up to 10% to secure a win.
If you are trading more volatile options such as 0DTE options, then you may set a stop at breakeven once the trade is up 30%, then move it up as your move is happening.
2. Tightening Your Stops
Continuously monitor the chart. Adjust your stop as the trade progresses in your favor.
Consider taking profits or maintaining a tight stop if a significant candle or volume spike occurs.
As you approach your target, tighten your stops or switch to a trailing stop to secure profits.
3. Keep Runners
Decide whether to keep runners after reaching your target, allowing you to capitalize on additional favorable movements.
Don’t Let a Trade Go Against You Twice
If a trade goes into negative territory but still looks promising, monitor it closely. However, if it turns positive and then goes red again, set tight stops.
Avoid letting a trade go against you twice to protect your capital.
Example: Putting Risk Management into Action
Suppose you invest $1000 in a trade with a 20% stop, risking $200.
Trade Fails: You stop out, resulting in a loss of $200.
Trade Almost Reaches Target: Moving stops as the trade progresses, you make a 20% gain, totaling $200.
Trade Hits Target: Trimming at the target, you make a 50% gain, totaling $500.
Now, if you take 3 trades in a day, you can lose 2 trades (total loss = $400), but win on only 1 trade (gain = $500), and come out with a net gain of $100. So you will still be green with a 33% win rate for the day.
The goal should be to minimize how much you lose on the losing trades, and try to gain more than you lose on the winning trades.
So then even with a poor win rate, you can still be slightly green, and as you improve your entries on good strategies, you will increase your win rate, thus significantly improving your net gains to be consistently profitable.