Consider this hypothetical situation. Let us assume that the average student learns his multiplication tables in the 3rd grade. Now, Micah is a really motivated student who loves to learn. In 2nd grade, he spends most of his days dreaming about how he will get to learn his multiplication tables in 3rd grade. However, in 2nd grade he is only learning addition. He gets itchy, and eventually gets so upset that he’s not learning multiplication that he drops out of school! Of course, this never happens in real life, but the entire situation is exactly what unfolds in the journey of most traders.
If we equate multiplication to becoming a consistently, profitable trader, we can see that as the main “daydream” of most traders. However, in order to learn multiplication, you have to learn the foundation of addition, and most traders are not willing to undergo the necessary preparatory stages that are required for profitable trading in the online forex market. One of the most important foundational aspects of trading is risk management.
Risk Management
Risk management is equivalent to Micah learning addition. The reality is that no trader will ever become consistently profitable unless he has a very strong handle on the issue of risk management. Now, let’s break this down a bit further. Most traders fail. That is a given. In general business practices, it is common knowledge that 80%-90% of small businesses will fail and close up shop in 1-3 years. In trading, the statistic of fatality is even higher, some estimates put the number as high as 90%+ of traders fail and give up. The reality is that most traders never graduate from the very elementary stages of trading—they never survive the learning curve.
The Learning Curve
There is a very real learning curve in trading. The learning curve involves many aspects including, but not limited to, risk management, strategy development, and trading psychology. Each of these major aspects of trading literally takes years to master, but new traders get so excited about trading, that instead of focusing on these fundamental aspects of trading, they take the first best forex course that they can find and then hurry into a live account and lose all of their money. If such a high percentage of traders fail during the learning curve, what is the key to surviving? The answer is simple—risk management.
Bringing It All Together
Now we see that simply surviving the learning curve is an absolutely essential element of trading success, and the greatest key to surviving as a trader is to simply not lose all of one’s trading capital, and this, of course, is done by employing proper risk management.
Many e-books and forex courses recommend placing 2% of account capital at risk on each trade. This is quite heavy, though. A new trader will undoubtedly endure losing streaks. If a trader endures a losing streak where he has 5 consecutive losers, which is highly probable at some point, this will result in over a 10% drawdown in the account. That can be quite a psychological blow to the trader, and most new traders will begin taking on even more risk as they have more losers in a deadly attempt to quickly earn back losses. Furthermore, when a trader risks 2% of account capital on a single trade, it is difficult to be emotionally detached from the trade because it is most likely a decent amount of money.
It is best for new traders to risk significantly less than 2% per trade. In fact, a new trader may do well risking only .25% or less of account equity on each trade. This will help him be emotionally detached from each trade because of the small amount of money at risk relative to account size, and this will help the trader make positive decisions, and his probability of surviving the learning curve will increase dramatically. Of course another key aspect of risk management that must not be forgotten is that you should never risk money that you cannot afford to lose.
