Risk Management Essentials
Risk management keeps you solvent. You'll learn position sizing, stop-loss placement, and risk/reward planning to survive volatility.
Who Is This For?
- •Traders who have taken a few trades and want structure
- •Anyone using leverage or multiple positions at once
Learning Objectives
- 01Apply the 1-2% risk rule per trade
- 02Place stops based on technical invalidation, not emotion
- 03Calculate risk/reward ratios before entering trades
The #1 rule of trading: Don't go broke. Everything else — entries, indicators, strategies — is secondary. If you manage risk correctly, you can survive bad trades, bad streaks, and bad luck long enough for your edge to play out.
Position Sizing
Position sizing answers the most important question in trading: “How much should I risk?”
📐 The Position Sizing Formula
Risk Amount ($) ÷ How far your stop is from entry ($) = How many units to buy
How much dollar risk you can tolerate. $10,000 account × 2% = $200 max risk per trade.
The price gap between your entry and stop-loss. Placed at technical invalidation — below support, above resistance.
The exact position size that keeps your loss at your target risk amount, regardless of how tight or wide the stop is.
🧮 Position Size Calculator
If stopped out: you lose $200 (2% of account). That's the plan.
Stop-Loss & Take-Profit Planning
Place at Invalidation
Your stop belongs where your thesis is WRONG — below key support for longs, above key resistance for shorts. If that level breaks, the trade idea is invalid. Don't place stops based on how much you want to lose.
Avoid Round Numbers
Everyone clusters stops at $2,000, $1,500, $1,000. Market makers hunt these levels. Place stops slightly beyond: $1,987 instead of $2,000. The extra $13 avoids the liquidity grab zone.
Use Alerts + Orders
Set price alerts before stop levels as early warning. Use actual stop orders on the exchange — don't rely on mental stops. “I'll sell if it drops” becomes “I'll wait a bit longer” every time.
⚖️ Risk/Reward Scenario Builder
Set your entry, stop, target, and win rate to see if the trade makes mathematical sense:
✅ Good — meets minimum threshold
✅ Positive expected value: over many trades at 45% win rate, you'd average +$35 per trade.
Portfolio & Emotional Control
📊 Multi-Trade Risk Tracker
Track total portfolio risk across concurrent positions:
📉 The Drawdown Death Spiral
This is why position sizing matters. Losses are asymmetric — the recovery gets exponentially harder:
| Account Loss | Remaining | Gain Needed | Reality Check |
|---|---|---|---|
| -5% | $9,500 | +5.3% | Minor setback — easily recovered |
| -10% | $9,000 | +11.1% | Noticeable but manageable |
| -20% | $8,000 | +25.0% | Requires disciplined recovery |
| -30% | $7,000 | +42.9% | Painful — takes patience |
| -40% | $6,000 | +66.7% | Very difficult to recover from |
| -50% | $5,000 | +100.0% | Need to DOUBLE your money to break even |
| -60% | $4,000 | +150.0% | Extremely hard — most traders quit here |
| -75% | $2,500 | +300.0% | Nearly impossible without changing approach |
| -90% | $1,000 | +900.0% | Account effectively destroyed |
💡 Key insight: A 50% loss requires a 100% gain just to break even. This is why protecting your downside is more important than maximizing your upside. Small, consistent losses (1-2% per trade) are recoverable. Catastrophic losses are not.
🧠 Pre-Trade Emotional Checklist
Check your mindset before every trade. Be honest with yourself:
🚨 Not ready to trade. Step away, review, and return with a clear head.
Common Mistakes & Gotchas
These mistakes trip up most beginners. Understanding them now will save you confusion later.
🛡️ Golden Rule: Amateur traders focus on how much they can make. Professional traders focus on how much they can lose. Risk management isn't about avoiding losses — it's about keeping losses small enough that your edge can compound over time.
Knowledge Check
Let's see how well you understood the material. Answer all 5 questions below.
What is the 1-2% rule?
Why set a minimum 2:1 reward-to-risk ratio?
How can a trading journal help discipline?
After a 50% drawdown, how much gain is needed to break even?
Why is correlation dangerous in a portfolio?