The Importance of Managing Risk

The concept of Risk Management is one of our core concepts here at Wanderer Financial. Why? Because properly managing risk is the single biggest factor in determining whether or not a trader will make money or lose money over the long haul. Understanding and managing risk is the key principle that separates wise, experienced traders, from the newbies who lose their shirts and then wonder what happened. Anyone who wants to trade for a living has to manage risk, first and foremost.

As traders, we need to learn to become masters at managing risk.

Our thirst for adventure needs to be kept in check when it comes to trading. To maintain a wandering lifestyle and stay in the game for the long haul, we have to learn to analyze and manage risk. Fortunately, successfully managing risk is a skill we can master.

You’ve heard the saying, “Don’t put all your eggs in one basket?” That saying can be applied here. As a trader, you wouldn’t wait for the perfect trading set up and then put your entire portfolio into that one trade. That may work great once, twice, or even three times in row. But what happens when it doesn’t work out? Worse yet, what happens when that trade goes wrong once, twice, or even three times in a row? Let’s do some simple math on a hypothetical trading account to see what would happen to that account during a prolonged losing streak.

Managing Risk

Scenario 1:  1% Risk (i.e. Loss) per Trade on a $100,000 account:

  • 1 Trade : $100,000 – 1% = $99,000
  • 2 Trades : $100,000 – 1% – 1% = $98,010
  • 3 Trades : $100,000 (- 1%) (- 1%) (- 1%) = $97,029
  • 4 Trades : $100,000 (- 1%) (- 1%) (- 1%) (- 1%) = $96,059
  • 5 Trades : $100,000 (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) = $95,099
  • 6 Trades : $100,000 (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) = $94,148
  • 7 Trades : $100,000 (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) = $93,206
  • 8 Trades : $100,000 (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) = $92,274
  • 9 Trades : $100,000 (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) = $91,351
  • 10 Trades : $100,000 (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) (- 1%) = $90,438

Scenario 2:  5% Risk (i.e. Loss) per Trade on a $100,000 account:

  • 1 Trade – $100,000 (- 5%) = $95,000
  • 2 Trades – $100,000 (- 5%) (- 5%) = $90,250
  • 3 Trades – $100,000 (- 5%) (- 5%) (- 5%) = $85,737
  • 4 Trades – $100,000 (- 5%) (- 5%) (- 5%) (- 5%) = $81,450
  • 5 Trades – $100,000 (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) = $77,378
  • 6 Trades – $100,000 (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) = $73,509
  • 7 Trades – $100,000 (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) = $69,833
  • 8 Trades – $100,000 (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) = $66,342
  • 9 Trades – $100,000 (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) = $63,024
  • 10 Trades – $100,000 (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) (- 5%) = $59,873

Scenario 3: 10% Risk (i.e Loss) per Trade on a $100,000 account:

  • 1 Trade – $100,000 x .90 = $90,000
  • 2 Trades – $100,000 x .90 x .90 = $81,000
  • 3 Trades – $100,000 x .90 x .90 x .90 = $72,900
  • 4 Trades – $100,000 x .90 x .90 x .90 x .90 = $65,610
  • 5 Trades – $100,000 x .90 x .90 x .90 x .90 x .90 = $59,049
  • 6 Trades – $100,000 x .90 x .90 x .90 x .90 x .90 x .90 = $53,144
  • 7 Trades – $100,000 x .90 x .90 x .90 x .90 x .90 x .90 x .90 = $47,829
  • 8 Trades – $100,000 x .90 x .90 x .90 x .90 x .90 x .90 x .90 x .90 = $43,046
  • 9 Trades – $100,000 x .90 x .90 x .90 x .90 x .90 x .90 x .90 x .90 x .90 = $38,742
  • 10 Trades – $100,000 x .90 x .90 x .90 x .90 x .90 x .90 x .90 x .90 x .90 x .90 = $34,867

Mathematically speaking, it takes bigger and bigger wins just to get back the money we’ve lost. For example, to earn back 5 consecutive losing trades of 10%, you’d need slightly more than a 69.5% gain. That’s a lot to shoot for!

The reason we are showing you these hypothetical horrors is that at some point in your trading career, you are going to encounter a series of losses. How much your total portfolio value suffers because of them will greatly impact the value of your account when you decide to retire. Worse yet, it could wipe you out. Our goal with Wanderer Financial is to teach you how to cut your losses short and let your winners run.

This is much easier said than done. We tend to hang on to our losers, waiting for them to turn around. Meanwhile, we sell our winners too early, because we don’t want to give back any of our gains. But in order to be successful, we need to do the opposite. Without a clear risk-management strategy in place, our instincts to hold on longer to a loser and sell a winner too early will take over.

At Wanderer Financial, we have developed a Risk Management Strategy that we teach, in depth, to our subscribers. This actionable strategy is an analysis tool that we use on every trade—it helps us to clearly define our entry, exit, stop price, position size, and the percent of risk to our overall portfolio. We apply it BEFORE entering any trade—when done correctly, managing risk is meant to keep you out of unfavorable risk/reward positions.

Successfully mastering this concept of Risk Management is what separates experienced, successful traders from novice beginners. It’s also what has helped to keep us in the game for the long haul, and has allowed us to keep on wandering.


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