Lecture 4: Risk Management in Trading

Why Risk Management Matters

Risk management is the process of identifying, assessing, and controlling the amount of capital you expose to each trade. It’s not about avoiding risk—it’s about managing it wisely.

Without it:

- You risk blowing up your account.

- Emotions take over.

- You lose consistency and discipline.

With it:

- You protect your capital.

- You stay in the game long enough to learn and grow.

- You trade with confidence and control.

💰 Position Sizing

This is the amount of capital you allocate to a single trade. It depends on:

- Your total account size.

- Your risk tolerance per trade (usually 1–2% of your account).

- The distance between your entry and stop-loss.

Example:

If you have $10,000 and risk 1% per trade, you should not lose more than $100 on any trade

🛑 Stop-Loss Orders

A stop-loss is a predefined price level where you exit a losing trade to prevent further loss.

Types of stop-losses:

- Fixed stop-loss: Set at a specific price level.

- Trailing stop-loss: Moves with the price to lockVolatility-based stop-loss: Adjusted based on market volatility.

Never trade without a stop-loss. It’s your safety net.

🎯 Risk-to-Reward Ratio

This measures how much you’re willing to risk versus how much you expect to gain.

- A common ratio is 1:2—risking $100 to make $200.

- Higher ratios (like 1:3 or 1:4) are better, but harder to achieve consistently.

Always aim for trades where the potential reward outweighs the risk.

📊 Win Rate vs. Risk-to-Reward

You don’t need to win every trade to be profitable.

- If your win rate is 50% and your risk-to-reward is 1:2, you’ll still make money.

- Focus on consistency, not perfection

🧠 Emotional Discipline

Risk management isn’t just about numbers—it’s about mindset.

Don’t revenge trade after a loss.

- Don’t increase position size impulsively.

- Don’t remove your stop-loss out of hope.

Stick to your rules, even when it’s hard.

📉 Drawdown Control

Drawdown is the decline from your peak account balance. Managing it is key to survival.

- Keep drawdowns below 20–30% to avoid emotional burnout.

- If you hit a losing streak, reduce position size or take a break.

🧪 Risk Management Tools

- Risk calculators: Help you size positions accurately.

- Trading journals: Track your performance and mistakes.

- Alerts and automation: Prevent emotional decisions.

⚠️ Common Mistakes to Avoid

- Risking too much on one trade.

- Moving stop-loss further away.

- Ignoring market volatility.

- Trading without a plan.

- Letting emotions override logic.