Risk Management to the Rescue!

Risk management will always be the most important thing to us when it comes to trading. In this article, we’ll show you exactly why, using trades that we took in our Trading Floor this week (26th Feb – 2nd Mar 2018) as a case study.

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What a crazy week it’s been. Crazy terrible, that is. We believe that transparency is key to learning and progress, that’s why we are willing to share our results with you no matter the result, win or loss. We’ll get straight to the point and say that this has probably been the hardest week of trading for us. As of today, we’ve taken 9 trades: 5 losses, 2 breakevens and 2 winners. That’s a 22% win rate. Surely we’re in a huge drawdown for the week. Unsurprisingly, we’re actually doing slightly better than breakeven. 

Who do we have to thank for this?

That’s right: risk management.

There’s so much we can say about risk management, but to simplify it as much as possible, risk management allows you to be profitable even with a terrible win rate. Let’s use this week as an example, trade by trade.

We actually started the week with a winner on EURJPY, an order that was leftover before last week’s close. Our stop loss was 15 pips and target was 45 pips. We always use “R” as the unit for risk. This is important to know.

This meant that we were risking 1R (15 pips) to make 3R (45 pips) and our risk/reward was 1:3. This also means that if this trade was a winner (which it was), we would have to lose 3 trades in a row to lose it all.

In essence, this is what risk management is all about: to make more than you lose, so you can afford to lose more than you win. In this scenario, when target was hit, we were up 3R for the week, and if we lost the next 3 trades (-3R), we would be back to breakeven.

And that was exactly what happened. We lost the next three trades. The first came from an AUDUSD long. We were risking 20 pips (1R) to make 60 pips (3R). The next came from a long on EURUSD. Just like the previous trade, we were risking 20 pips (1R) to make 60 pips (3R). The next loss came from a USDCHF short. Unlike the other two, we were risking 15 pips (1R) to make 60 pips (4R).

We started the week off with +3R from EURJPY. After 3 losses in a row (-3R), we were down to 0R (+3R – 3R), essentially going back to breakeven. That’s a 25% win percentage. Without proper risk management, we would possibly be in a drawdown, but because we took calculated risks, we were not yet in the red.

After 4 trades, we were back to breakeven. We mentioned that we took a total of 9 trades this week. The next 2 trades resulted in breakeven because of trade management. We moved our stop losses to breakeven before getting stopped out. One of the trades was a short on AUDJPY. You’ll see that we were risking 20 pips (1R) to make 65 pips (+3.25R).

Why is it 3.25R? Just take your TP divided by your SL. 65/20 = 3.25

In hindsight, you can see that price actually hit our take profit level. However, the reason why we got stopped out for breakeven is because after our entry, prie made a strong push downwards and that’s when we moved our stop loss to breakeven. Unfortunately, price retraced to retest our entry (essentially stopping us out), before going on to hit our target. Unlucky, but this is the reality of trading.

In total, after 6 trades, we were still breakeven at 0R (+3R -1R – 1R -1R + 0R + 0R = 0R).

The next two trades were losses from EURGBP and AUDJPY, with the latter being the more unfortunate one. We identified several supply zones (red boxes) and decided to place a sell limit at the second one from the bottom.

Unfortunately, price shot up through that supply zone before reacting and rejecting the one on top. Consequently, price went on to hit our target. 

These two losses meant that after 8 trades, we were down -2R (+3R -1R – 1R -1R + 0R + 0R – 1R – 1R = -2R).

That brings us to our latest (and probably last) trade of the week: a short on EURJPY. For this setup, we were risking 30 pips (1R) to make 80 pips (2.67R). 80/30 is 2.67

We took this setup based off a harmonic pattern setup. A potential Cypher had formed and we placed a sell limit at completion. From the picture above, you can see that price immediately reacted with our entry before reversing aggressively towards our target. This was only our second winner of the week.

This winner meant that after 9 trades, we were up +0.67R (+3R -1R – 1R -1R + 0R + 0R – 1R – 1R + 2.67R = +0.67R).

Not too impressive, but it will always be better than being at a loss. This article is proof that with proper risk management, you can remain profitable even with a terrible win rate. It’s always better to boast a positive long term expectancy than a high win rate, because more often than not, a high win rate does not equate to profitability. If you have a good risk/reward ratio on every trade and a system that has proven itself through backtesting, then all you need are a few winners among the many losers to come out on top.

Remember, trading is a marathon, not a sprint.

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