Attitude to risk

In almost every financial investment or trade, you’ll need to be prepared to accept a certain degree of risk

In some cases, the possibility of a substantial loss may be high, although on the other hand there may be the potential for large gains. So before you open any position, it’s important to assess the level of risk involved and decide whether you feel comfortable.

Your perception of risk

We all have our own views and feelings about risk. For example, a CFD trade on a new and undiscovered company’s stock might feel like an exciting opportunity to one person, while another would regard it as too dangerous and stressful. 

On the other hand, buying shares in a stable blue-chip company might seem like a secure choice to some people, while others could be put off by the long-term nature of the investment and the relatively low potential returns.

So an opportunity that appeals to somebody else may not necessarily be right for you, and vice versa.

How much should you risk?

Choosing how much to risk is very dependent on your personal circumstances. Some guidance will advise you not to risk more than 1% of your dealing capital (the total amount of money you can dedicate to trading) per position, while other sources recommend up to 10%. 

If you choose to risk 10% or more per trade, bear in mind that any losses could have a huge effect on your overall capital and your ability to claw back the money lost. 

Example

Say you have £10,000 of trading capital and you’re unlucky enough to make a loss on 15 trades in a row. Below you can see the difference between risking 2%, 5% or 10% per trade:

With 2% risk per trade, even after 15 losses you’ve lost less than 25% of your capital. It’s conceivable that you can get this money back.

However, with 5% risk, you lose over half your initial capital. You’d have to more than double this amount to get to your original level.

At 10% risk, things are even worse. You’re down over 75%, making it extremely difficult to recoup the money you’ve lost.

The reduction of capital after a series of losing trades is called a drawdown. It’s important to work out what percentage of drawdown would make it difficult to reach your trading goals, and then ensure your risk per trade is in line with this.

All traders will be affected by a losing streak at some stage, but those who acknowledge this and plan their dealing accordingly are usually more successful in the long run.

Calculating risk vs reward

A certain level of potential reward may make you feel that a degree of risk is worth taking. And if you achieve the right ratio between risk and reward, it’s possible to be consistently profitable even when you’re losing more trades than you win.

To find the ratio on a particular trade, simply compare the amount of money you’re risking to the potential gain. You can work out these figures from the positions of your stops or limits and your expectations of the likely market movement. So if your maximum potential loss on the position is £200 and the maximum potential gain is £600, then the risk vs reward ratio is 1:3.

Example

Let’s say you place ten trades with the risk vs reward ratio 1:3 and are successful on just three of those trades. Your profit and loss figures might look like this:

Over ten trades you could have made £400, despite only being right 30% of the time.

Discover our free trading courses

Learn from our experts at IG Academy, with step-by-step online courses, plus webinars and seminars designed to help you build your trading skills.

You might be interested in...