Do you know exactly how much you risk each time you place a trade?
In his recent article ‘The Commitment Secret’, Dr. Kenneth Reid challenged us to commit to an ongoing process of self-improvement. In today’s article, we want to consider the topic of trade risk.
Do you clearly define the point at which you will exit a trade if it goes against you?
If we trade without pre-defined exit points, our risk is infinite. As such, it is impossible to calculate the financial risk of that trade, and exposes our entire account to risk. Not only is this extremely bad for our pocket, but it’s also a source of a immense emotional pain and psychological damage.
In this scenario, where would we exit the trade, and by then how big will that loss be?
Do you clearly define how much of your account you will risk on each trade?
If I enter a trade with the same lot size for each currency pair, then I am not defining my risk. Why? Because each currency pair has a different cost per pip. For example, one standard lot on the EURGBP is around $12.80 per pip, whereas one standard lot on the GBPAUD is around $7.50 per pip. So the risk on the two trades is not the same with an equal lot size.
Why should we define the risk on each trade?
If we consider how we bet on a horse race then the answer is quite simple.
The odds are calculated on the probability of a horse winning and we use those odds to define our trade parameters. So, for example, if the odds are 10:1 and I bet $1, then a win would return my $1 stake and $10 in profit. However, if my horse does not win then the bookie keeps my $1 bet. In this scenario, I fully understand that I will lose $1 if my horse does not win and I have considered it a worthwhile trade as I have the chance to make $10 by risking $1.
Now, if the bookie couldn’t tell me how much I will lose if the horse fails to win, but that it might be all the money in my account, (which, incidentally, he holds for me in his own bank account) would I then take a bet on that horse? I certainly wouldn’t – but yet, surprisingly, many traders do.
What are the benefits of defining and accepting the risks on each trade?
How about I say you can be the bookie (to define the trade odds) and then also the customer to take that trade? Well, that is just what we do when we trade.
So, for example, I could set a stop loss at -50 Pips and take profit at +100 pips (1:2 risk to reward) and then risk $100 on the trade. If the trade stops out I lose $100 but if the trade is a winner I will gain $200.
But just remember, as the bookie or as the customer, I have no way to determine or influence the outcome of the race, I am just defining my trade parameters and must accept the outcome.
The skill in trading is then to find high probability trades and to pre-determine the exit, which is the subject for another day.
How do we determine the risk in Hawkeye Tomahawke FX?
Using the Tomahawke method, we use a trade execution tool to place our trades quickly, as we are trading the shorter time charts.
This tool makes us place a stop in the charts. We think about and determine the point to exit that trade should it go against us. In the settings, we also pre-determine how much of our account we wish to risk on each trade (normally ½ percent on each trade).
When we take a trade, the software automatically calculates the lot size given the number of pips to the stop and the total value we are risking on that trade. So, for example, if we are risking $100 on a trade with a 10 pip stop, then we risk $10 per pip. The software calculates that as a lot size and enters the trade. Should the stop be hit, we will lose $100 and no more. We accept this as our defined risk.
I hope this article helps you to think about risk in your trades and how to become a better trader.
Join Me in the next free LIVE Hawkeye Demonstration Room held every Wednesday at 9.30am EST US. You will learn more about volume and volume price analysis and see more examples and live trade setups. It is open to all.
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