Risk Management in Trading
This podcast community at Market Mamas is our platform to speak authentically about the real day to day challenges of learning to be consistently profitable day traders. Everyday we do the best we can to get 1% better and add value to our lives and our pursuits. So, we hope we can add some value to yours as well! And for our value add now, we are going to talk about an incredibly important topic for all traders of any specialty - it is Risk Management! Risk Management truly is a pillar in any profitable, strong, and successful trading system.
Logistical
The deeper we get into our trading careers, both Kendra and Becky now understand risk management so much more deeply than we ever had during our first year or more. It is both a logistical AND a psychological topic in fact. So, first, let’s talk logistics!!
If you’ve studied trading at all, you’ve likely heard about the Risk: Reward ratio or the “R factor.” This is what you will risk in a given trade based on your stop loss placement within your trade bracket order. For example and to keep the numbers simple, based on your trade plan and position size, you may be planning a $100 risk for your trade. The ratio is in comparison to your profit target intentions. So then, if you have a 1:1 R factor, then your profit target is $100 from your entry price. A 2:1 trade would then have a profit target of $200. For the greatest impact to your account and a sustainable upward trajectory of your trades, it is recommended to have more than a 1:1 risk to reward ratio. And that makes sense, right? Over time, your wins should outweigh your losses to grow your account the most effectively.
Now about an appropriate stop placement. We like to really prioritize the question: “Where is my trade setup wrong” when placing your stop. It needs to respect your pre-identified trade plan levels, support or resistance, a structure, trend line - whatever you're basing your bias on. It’s really hard to stay in if you don’t give your trade the room it needs to breathe. It is not advisable to just place your stop loss at a set amount of points. A really good entry can help a great deal with this. Sometimes you can catch a really powerful momentum breakout that’s straight into profit, but more often, it usually requires waiting for price to go against your direction and then executing if you want the best R:R. Also, we’ve found respecting the risk you put on for that one setup is a key factor, and if you get stopped out, then move on. It’s so much easier to find another entry or better setup than hold onto a losing position and let your trade bleed.
Another key factor to consider is the percentage of your account size you will risk in one given trade in order to stay in the game long term.
Younger traders need to take smaller hits to keep their account viable to trade and learn. If you start with a 10k account for example, but risk $1,000 on every trade you enter and then take the full stop outs, you only have 10 loss chances of surviving with this account, or a bit more once some wins get mixed in. And blowing it in a few days to weeks by going heavy is really unnecessary and will teach you WAY less. You essentially then have a much smaller sample size of trades that are teaching you, vs if you only risk $50 per trade with a 10k account, then you have 200 stop outs. So even if you win zero trades, that is still 200 executions that will educate you if you are listening. This keeps you viable with a live account to learn and pay your market tuition over time and at a steady rate that doesn’t break your heart or bank account in the process. With this approach, you have a shot at not ever blowing an account in fact, as it can be sustainable with your growth and education.
Now, middle to advanced traders with a solid edge and a bit more experience can more readily spot a superior setup and may choose to accept more risk with a higher probability of the trade being accurate. Essentially risking a larger percentage of your accounts on your best pitch when you identify it setting up. Maybe you have a real tried and true, bread and butter setup that has a very high win rate for you. Well, I might enter that trade with double my standard lot size, as I recognize a higher probability of winning means these are fundamentally less risky trades. And that is a factor to consider when you have gained the experience required to make those analyses for yourself and your system.
Sustainability is about respecting your account size and having a daily loss limit for your system in order to stay in the game. So, a hard stop is a crucial part of a day traders ability to keep accounts active and healthy. There are days when staying cash is the best form of risk management. But if that fails, then a hard stop can protect you on off days when you can't get in sync or just underperform for any reason. It can be really difficult to turn a red day around especially if you engage in over-trading and fix-it mode and don’t want to take a small loss on your day. It can go from bad to worse real quick!
Want another helpful tip for improving your risk management? It is to journal all your trades! Journaling will show you your stats and then you can adjust with your data. Numbers wise: perhaps historically you start out the week with losses so maybe you reduce risk on Mondays based on your data. Some people also consider if you have a nicely green week, then on Friday you may choose to reduce risk, so you ensure you go into your weekend green on the week regardless! It is inevitable for many traders to not experience some emotional carryover from losing sessions. And those traders may choose that added caution on Friday’s especially to preserve their vibe going into their weekend if Fridays are statistically a struggle day for them and their system. Same goes for certain market conditions. Do you have a pattern of trading tilt in certain conditions? Types of days or patterns that are just inherently more difficult for the type of trader that you are? Well then, can you limit your exposure and risk on those days? It is certainly worth considering as a part of your system’s risk management. Becky, for one, struggles most on bullish trending days. She has tried to catch the top tooooo many times. So, if she analyzes and reads that this may be the day ahead, she approaches her day with more caution and a specific approach that prioritizes her staying very calm and focused with her trading plan and execution choices. This is an adjusted trade plan given her known trading statistics.
“Do what is right, not what is easy.”
~ Unknown
Now, we won’t get too technical beyond this, because we really want to dig into the heart of the risk management challenges. And that is truly embracing, trusting, and exhibiting strong risk management in real time trading. Understanding technically how to place and what makes an appropriate stop loss for different market conditions will come over time and with experience with your instrument of choice. But every trade and every session, respecting yourself and your trading business enough to consistently follow your risk management - that is the core obstacle to consistency in your outcomes.
Psychological
Truly accepting risk is critical. Saying “I love risk” has been Kendra’s mantra for the better part of 2024, because she recognized that she really needed to rewire her brain to fully accept and EMBRACE that this is a game of risk that we’re playing. This quote hits home for us when we reflect on how we tried to avoid it early on. “Some failure in life is inevitable. It is impossible to live without failing at something unless you live so cautiously that you might as well not have lived at all. In which case, you fail by default.” J.K. Rowling
We’ve done a lot of work to within ourselves to change that channel in our minds to risk being on our side. It's what gives us this great opportunity. It’s what’s required to give life and let our trade plans and systems serve us.
We indeed love capitalizing on an A+ setup so much! But, these days are not always the outcomes, right? That’s why we have to have risk management to remain in the game. On a whole, there are at least two distinctly different ways of exhibiting a forfeit of risk management and experiencing a trauma day. Interestingly, Kendra and Becky are opposites in general on this. On the few and far between tilt days for Kendra, she experiences this by way of multiple stop outs. Engaging in fix it mode while still honoring the stop placement of each trade. But repeatedly just getting back in with the market after each hit to get back to green or even a small loss. But in this scenario, if we are not taking a break after multiple losses, maintaining a clear mind and ideal focus generally becomes very irregular and unreliable. Sometimes in this mode, a trader can also forget to eat, ignore the other to-do lists and responsibilities, and generally just mismanage the entire day and end up feeling awful.
For Becky and her style, most of her tilt days occur in the manner of overleveraging and/or dollar cost averaging (DCA) and allowing just ONE wrong trade to blow accounts! It’s wild really and something she is working deliberately to improve. Because she has added to losers to the point that her account can no longer hold the risk of the size of the trade and her accounts blow as the price action just continues to pull away from her. In this space, she chooses to tune out reason, data, and logic. And instead refuses to be wrong and Becky and her ego ride that sucker into the ground. This is not ever sustainable for an account and causes undue pain to the trader every time.
Accepting risk means accepting you are wrong or your read was incorrect at the time when your support or resistance level failed. And when you are wrong, you must cut your trade because your setup is no longer valid once you have that data that the level failed to hold. We have to then let the ego go. An ego will kill you in trading. It’s far superior to make your system factual - if you traded based on a support and that support fails, your trade plan is no longer valid. To be successful as a day trader, we have to love the perspective and practice to Live to Trade Another Day. Also known as a long game mentality, a growth mindset, and making a red trade educational so it is productive and not traumatic or painful.
Another often overlooked part that can help with cultivating strong risk management stems from keeping a healthy outlook and tuning out and turning off your trading brain when it’s time to. Early in our trading careers, we recall being in the shower and thinking about the charts. Dreaming of candlestick patterns and trade setups. So, now on losing days when we mess it all up, we understand the importance of not ruminating on it. To be honest, we've had tearful mornings getting our boys off to school some days. But instead of being ashamed, we’ve really leaned into showing them that it’s ok. We reassure them and ourselves really, that Mommy is doing something extremely difficult and we have days that we disappoint ourselves. Having time away from the charts though and connecting with them does refresh and center us. Modeling that resilience and that big emotions are ok is important. Not to get too off-topic from risk management, but we do believe trading has made us more well-rounded parents as well. In our Mothers who trade episode, we featured the Parenting Manifesto by Brenee Brown–that is just wonderful if anyone wants to look that up! (https://youtu.be/avpFUNlNT7Y?si=GrOxo8k1fFN0g-_D)
Those days when you just cannot nail your trade for anything, they sting something fierce because you may have had a really good plan and you just fumbled the ball. And then you could experience throughout the day a period of acute annoyance watching the market just plugging right along without you and your accounts were all red on the day. We’ve done this. And on those days, in the evening when we reflect on it and do our process of journaling and thinking about what we did right and what we want to do differently. That's when we’re like, okay, you know what? I actually protected my accounts because I really did respect my levels and I accepted the stop out because I didn't have the ideal entry. Prioritizing the fact that this just wasn’t a winning day and statistically, this will happen.
This is actually a win. Which is a hard thing when you are growing into trader maturity to recognize a red day within your risk tolerance as being a win, but it is! There are micro wins even in the struggle. And if we can see the positive in that and the growth through it, the journey feels so much better. By the end of these struggle days, we can actually feel proud that we were able to let the day lie in a safe position. Getting through these days and just being able to walk away and lean into our fundamentals and recognize that if we are by and large at least 60-70% green as a trader, we’re good.
There's a reason why we have a protective stop. And we love that term so much more than a stop loss. It's a protective stop because it's designed to protect your accounts and your progress. So walking away and recognizing that you have an edge, you have fundamentals, you are a good trader and there's always tomorrow. The market is abundant. This is literally the abundance, the growth mindset that we’re trying to always make sure we’re living in instead of the struggle and the strife and a potential worry that Miss Market’s not gonna come back for us and we need to lock it in right now. Because this is what holds us back. And we don't need to hold ourselves back. There's enough struggle in learning to be a consistently profitable trader. It’s so much better and more neutral to settle down, accept the game of probabilities, and let each day live on its own. This is risk management in practice.
Any day can present a whole different story and be complicated or not, be a great clean training session or not. That's the goal to not be living in any one day in any one loss and that one outcome for the day, but to just honor the bigger picture. These choices are a vote! We love the Atomic Habits quote: “Your identity emerges out of your habits. Every action is a vote for the type of person you wish to become.” It never feels comfortable, right? Because growth is uncomfortable.
Regarding any loss in trading, we say: feel it, learn from it, tell someone, take a break if you need to, and then focus on the next ‘one good trade’ - this is what a trader does. Own what you did, but if you really want this, re-focus on your system, remind yourself of your skills and how you want to be, both with wins and small losses, and then get back in the arena. And, sorry, not sorry, don’t discuss risk management with non-traders. They will not understand and will question if it is “gambling.” DO discuss it with a fellow player from your locker room. But not with parents, friends, even potentially spouses unless they have a decent understanding of trading. Conversations on this need to be productive and reasonable and with someone with an understanding of your system to actually benefit you, in our humble opinions. Hang in their guys! All of this gets easier with time and perseverance. We got this!
Thank you to everyone who is subscribing to our podcast, reading our blogs, and providing us feedback! We are here to talk openly about everything that may help us all level up within our lives, be it day trading or otherwise. We wish you all the very best for your lives!