Manage your risk

 How you decide to split your resources will depend on the amount you have to trade as well as your own attitude to risk. The more risk capital you have, the more you can divide it up. This in turn will give you more trading opportunities. Overall the aim is to keep losses manageable, so you still have enough risk capital to continue trading. Then you will find it easier to run your winning trades and look to lock in bigger profits. Doing this consistently over time is the key to successful trading.

It will also help with another essential part of your trading plan - developing clear instructions for the size of your trades in relation to the amount of money in your account. Once you’ve decided on how much you’re willing to risk on each trade, you have to apply this limit every time you discover a trading opportunity. We’ll illustrate this point with an example:

Let’s say that you have trading capital of $4,000 and you decide that the maximum you’re prepared to risk per trade is $90, or 1%. Now, perhaps you have been following the UK 100 market - it’s trading around 6,355 and trending upwards. You do want to buy the index just not at current levels.

Instead you identify a buying level around 7,320 while a good selling opportunity comes in around 6,400. You believe that is an area of resistance, marked by the inability of the index to break above this price. You now have the potential for a trade. You decide to put on a limit order to ‘buy’ at 7,320, you aren’t buying at current levels but setting a limit at the price you are prepared to pay. You also attach a sell order to your limit order which will be a take profit at 6,400 – potentially an 70-point gain.

You have already decided that you will risk no more than $100 on the trade, so you could simply put an order to buy $10 per point at 7320 with a stop 10 points below for a risk of $100. But this takes no account of how the UK 100 may swing around even if the overall upward trend remains in place. In fact, the chart tells you that the UK 100 could fall back to 7,300 where there is a major support level, and the upward trend would remain in place. You decide to put a stop in at 6,295 – 15 points below opening level. To make sure your risk is around $100, this would mean opening a trade of $3 per point, at the most. You may decide to be more cautious and limit it to $2, hopefully keeping the potential loss to $50 (assuming no slippage).