Assessing the risk of a trade is one of the biggest challenges any trades faces when planning the operations. It’s much easier to focus on the potential profits of a big trading opportunity spotted, getting seduced by those big figures, than calculating the potential losses one wrong turn can trigger.

That’s where a lot of mistakes happen, as miss-calculating the risk of a drawdown can have severe consequences to any trading account, no matter the size. Walter Peters, trader and owner of FXjake, admits this was his biggest error:

"My biggest mistake was not understanding probabilities. It's embarrassing to admit, particularly because in graduate school I received a minor in statistics, with an emphasis on categorical data analysis. This is precisely what we deal with as traders (win or lose). Once you understand how probabilities affect your likely outcomes, you can literally avoid the number one "trader killer" which is the dreaded drawdown.

Like many traders, I focused on the end goal (profits) and did not spend enough time considering the effect of a drawdown on my psychology and my resiliency. But once I understood how to project likely scenarios using statistics (and in particular probabilities), everything changed.
You will feel more in control once you calculate your risk of drawdown, because you will know how to avoid it. I would encourage you to 1) identify the draw down you want to avoid and 2) calculate the risk of reaching this drawdown level, so you can continue to trade without running into the emotional brick wall that is the catastrophic drawdown."

Russell Shor, an independent senior markets analyst, puts that into numbers:

“The biggest lesson is to understand the mathematics of risk. A 10% loss is not offset by a 10% gain. Think about it like this: a 50% loss needs a 100% gain on remaining funds just to break-even; a very steep feat indeed. My mistakes have always been overcommitting capital to a single trade. If the trade doesn’t work out it has damaged my trading account more heavily than necessary. Risk control ! Risk control! Risk control!”

That reads as a textbook argument that, once learned, should never be forgotten. But, of course, the odds of getting trumped by risk miss-management get bigger once you get on a good run of trades, developing an over-confidence than can end up with the trader forgetting about its own rules. Dmitriy Gurkovskiy, senior analyst at RoboForex, has a name for this, The “Market God Syndrome”:

“A typical issue is the so-called "Market God Syndrome", which may become a problem of an experience trader, not actually a novice. When a trader has a good winning streak and increases his capital by a few times through a small period, they easily increase the position size and the number of traders they make. As a result, they forget about their risk management system, which may lead to margin call and stop out very quickly after just a few losing traders without any critical movements. It’s something I have faced in my trading career”.

One could also read as “don’t win too much, too quick, too easy”, as it might end up being your own trading grave.

 

Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. You should do your own thorough research before making any investment decisions. FXStreet does not in any way guarantee that this information is free from mistakes, errors, or material misstatements. It also does not guarantee that this information is of a timely nature. Investing in Open Markets involves a great deal of risk, including the loss of all or a portion of your investment, as well as emotional distress. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of FXStreet nor its advertisers.

Education feed

Editors’ Picks

EUR/USD rebounds after dismal US PMIs

EUR/USD is trading closer to 1.0850, rising in response to weak US PMIs, with the services one pointing to contraction. Earlier, German Manufacturing PMI beat estimates. 

EUR/USD News

GBP/USD advances to 1.2950 after US data

GBP/USD is trading around 1.2950, taking advantage of US weakness stemming from a downfall in Markit's Services PMI in the US. In Britain, the Manufacturing PMI exceeded estimates. 

GBP/USD News

USD/JPY retreats from highs amid coroanvirus fears

USD/JPY has fallen from 112 as coronavirus fears trigger safe-haven flows into the yen. Investors are shrugging off disappointing Japanese figures.

USD/JPY News

Editors’ Picks

EUR/USD rebounds after dismal US PMIs

EUR/USD is trading closer to 1.0850, rising in response to weak US PMIs, with the services one pointing to contraction. Earlier, German Manufacturing PMI beat estimates. 

EUR/USD News

GBP/USD advances to 1.2950 after US data

GBP/USD is trading around 1.2950, taking advantage of US weakness stemming from a downfall in Markit's Services PMI in the US. In Britain, the Manufacturing PMI exceeded estimates. 

GBP/USD News

USD/JPY retreats from highs amid coroanvirus fears

USD/JPY has fallen from 112 as coronavirus fears trigger safe-haven flows into the yen. Investors are shrugging off disappointing Japanese figures.

USD/JPY News

Top 3 Price Prediction Bitcoin, Ethereum, Ripple: Consolidation process underway

The Crypto board continues to be immersed in an emotional leg-breaking, consistently punishing the emotional state of the traders with its continuous changes of direction.

Read more

XAU/USD unstoppable, breaks to fresh 2020 highs, approaching $1650/oz

XAU/USD is trading in an uptrend above its main daily simple moving averages (SMAs) while breaking above a bull channel. Gold is printing fresh 2020 highs hitting $1646.64 per ounce on an intraday basis.  

Gold News

RECOMMENDED LESSONS

7 Ways to Avoid Forex Scams

The forex industry is recently seeing more and more scams. Here are 7 ways to avoid losing your money in such scams: Forex scams are becoming frequent. Michael Greenberg reports on luxurious expenses, including a submarine bought from the money taken from forex traders. Here’s another report of a forex fraud. So, how can we avoid falling in such forex scams?

What Are the 10 Fatal Mistakes Traders Make

Trading is exciting. Trading is hard. Trading is extremely hard. Some say that it takes more than 10,000 hours to master. Others believe that trading is the way to quick riches. They might be both wrong. What is important to know that no matter how experienced you are, mistakes will be part of the trading process.

Strategy

Money Management

Psychology