Risk and money management are key to survival as a trader like they are in life. You can be a very skilled trader and still be wiped out by poor risk and money management. Your number one job is not to make a profit, but rather to protect what you have. As your capital gets depleted, your ability to make a profit is lost. Here is everything you should know about risk and money management, presented together because they are intimately related.
The Essence of Good Risk and Money Management
To be motivated to practice good risk and money management, you first need the right mindset. Risk and money management is all about the following, which we cover in detail in NAGA Academy:
- Trading with more conservative styles and methods.
- Making sure your gains from winning trades are larger than your losses from losing trades.
- Increasing the odds of favorable risk-to-reward ratios.
- Preventing a fatal loss from one or a series of losing trades from which you’re unlikely to recover without adding funds.
Why Risk and Money Management Matter
Trading isn’t just about making profits—it’s about surviving and thriving in the long run. Even the best traders can lose everything if they ignore risk and money management. The secret? Protect what you have so you can profit tomorrow.
The harsh truth about losses
Losses hurt more than gains help. Here’s why:
- Lose 20% of your capital? You need a 25% gain just to break even.
- Lose 50%? Now you need to double your money to recover.
- Lose 90%? You’ll need a 900% gain to get back to where you started.
Bottom line: It’s not just about winning—it’s about not losing big.
What is Money Management?
Money management is the art of controlling how much you risk on each trade. Experienced traders only risk a small portion—usually 1–3% of their account—on any single position.
- Small, controlled losses are easy to recover from.
- Big losses can destroy your account and your confidence.
Example: If you have $1,000 and risk 2% per trade, your maximum loss per trade is $20.
What is Risk Management?
Risk management is about making sure your average loss is always smaller than your average gain. Even if you’re right only 40% of the time, you can still be profitable—if your winning trades are much bigger than your losing ones.
- Aim for a risk-reward ratio of at least 1:2 or 1:3.
- This means for every $1 you risk you should aim to make $2 or $3.
The Three Pillars of Risk and Money Management
The size of this maximum allowable loss per trade depends on three conditions:
- Account size: Determines the cash value of the 1 to 3 percent maximum loss you can afford. Thus, it determines how far you can set your stop-loss orders from your entry point. The larger the account, the wider the stops you can afford, and the more choices of trades you have available to take. For a given trading account size the maximum loss you can safely afford is a function of the following two factors.
- Stop Loss: Pre-define the potential loss you accept in each trade. The wider the stop loss, the smaller the position size (or volume) you can afford without exceeding that 1 to 3 percent. The tighter the stop loss, the larger the position size (or volume) you can afford without exceeding that 1 to 3 percent. Remember that stop-loss orders are used only to limit losses as price is not guaranteed in abnormal market conditions.
- Position size: Determines the cash value of each pip or point. For a given account, the larger the lot size used, the more every pip or point moves against your costs. The larger the lot size, the higher the risk and profit potential.
Let’s look at these in greater detail. All focus is on ensuring that your stop-loss setting doesn’t risk more than 1 to 3 percent of your capital and that gains per winning trade are much larger than losses per losing trade.
Money management calculation
Here are the 3 steps for proper money management calculation:
Step 1 - Set Your Account Risk Limit per Trade
This is the most important step for at least having a chance to succeed, even for smaller, realistic returns. Any returns! Without it, failure is guaranteed before even starting.
Set a percentage or dollar risk limit, you'll risk on each trade. Most professional traders risk 1 to 3 percent of their account’s balance or equity if other trades are open.
For example, if you have a $1,000 trading account (equity, not balance), you could risk $10 per trade if you risk 1% of your account on the trade. If you risk 2%, then you can risk $20. You can also use a fixed dollar amount, but ideally, this should be below 2% of your account. For example, you risk $15 per trade. If your account balance goes to $985, then you'll be risking 2% or less. While other variables of trade may change, account risk is kept constant. Choose how much you're willing to risk on every trade and then stick to it. Don't risk 5% on one trade, 1% on the next, and then 3% on another. If you choose 2% as your account risk limit per trade, then every trade should risk about 2%.
Step 2 - Determine Pip/Point Risk on Trade
You know what your maximum account risk is on each trade, now turn your attention to the trade in front of you.
Pip/Point risk on each trade is determined by the difference between the entry point and where you place your stop-loss order. The stop-loss closes out the trade if it loses a certain amount of money. This is how risk on each trade is controlled, to keep it within the account risk limit discussed above.
Each trade varies though, based on volatility or strategy. Sometimes a currency trade may have five pips of risk, and another trade may have 15 pips of risks. When you make a trade, consider both your entry point and your stop loss location. You want your stop loss as close to your entry point as possible, but not so close that the trade is stopped out before the move you're expecting occurs.
The following rules on stop loss setting assume you’re going long near strong support level or short near resistance level because if you aren’t, you shouldn’t even consider entering the trade. If the trade moves against you, that nearby key level is quickly breached, and you have a signal to exit before a small loss becomes a large one.
When setting your stop-loss order, you’re always striking a balance between two conflicting criteria:
- The stop-loss price is close enough to your entry point so if it’s hit, the loss doesn’t exceed 1 to 3 percent of your account value, as noted previously.
- It’s far enough away from your entry point and the likely support and resistance levels so it doesn’t get hit by normal random price movements and close your position before the price has had time to move in your favor. Rather, it’s triggered only by price moves that are big enough to suggest that you were wrong and overestimated the strength of a given key zone, and now a loss is more likely than you thought. It’s time to close the position before a small affordable loss becomes a large one. There are different ways to determine the normal or average price movement to expect during a given period. Some manually determine the average or typical candle length over a given period. Some will use a certain percentage of the range as determined by the Average True Range (ATR) indicator. Price volatility varies with market conditions and time frame as must the distance from the entry point to stop loss.
Once you know how far away your entry point is from your stop loss, in pips, you can calculate your ideal size for that trade (step 3).
Let's take our example into consideration, and recap the above:
- Risk management criteria: Aim for a 1:3 risk-to-reward ratio. In other words, the distance in pips from our entry point to stop loss should be no more than about a third of the distance from our entry point to our profit-taking point (near the high in the case of long positions, near the low in the case of short positions). That way our winning trades produce gains that make up for multiple losses.
In other words, each successful trade should bring you at least 3x2%= 6%.
Favorable risk-reward ratios are another key part of good Risk and Money Management. We seek 1:3 risk-reward ratios (aka 3:1 reward-risk ratios, same thing) or better, though we will certainly consider trades with 1:2 risk-reward ratios, as shown in our Risk-Reward Ratio guide. That way your winning trades bring gains x3 the size of your losses. That allows you to be profitable with an achievable winning trade percentage of just over 25 percent.
Play smart with your Stop Loss (manually or using a Trailing Stop Loss):
- first, move your Stop Loss to the entry point (breakeven) so that you make sure you avoid a loss, once the trade makes a decisive move in your direction (or at least your floating profit equals your initial risk of 2% in value)
- then, move your Stop Loss to positive territory, locking in at least 2% that can cover the next loss.
- continue to maximize profit using the above logic.
Remember, with a 1:3 risk-reward ratio, as long as you’re right more than 27.5 percent of the time, you’ll be profitable.
Step 3 - Determine the Lot Size
Position size is usually the easiest one to keep your maximum loss risked per trade in control and, at times, is the only one. Your position size is how many lots or contracts you take on a trade. Position size is a simple mathematical formula equal to:
Pips/Points at Risk X Pip/Point Value X Lots traded = $ at Risk.
We already know the $ at-risk figure, because this is the maximum we can risk on any trade (step 1). We also know the Pips at risk (step 2).
All that leaves us to figure out is the lots traded, which is our position size. Assume you have a $1,000 account and risk 2% of your account on each trade. You can risk up to $20 and see a trade in the EUR/USD where you want to buy at 1.3035 and place a stop loss at 1.2995. This results in 40 pips of risk.
You can use a lot size calculator or do some manual calculations. Your 40 pips stop loss should generate not more than $20 loss. So, your position size should be a maximum of 0.05 lots (or 5 micro lots).
NAGA WebTrader allows traders to set stop loss orders in two ways: amount and specific rate.
Pro Tips for smart risk and money management
- Be consistent: Stick to your risk limit on every trade.
- Use trailing stops: Lock in profits as the trade moves in your favor.
- Move to breakeven: Once your trade is in profit, adjust your stop-loss to your entry point to eliminate risk.
- Never chase losses: Stick to your plan, even after a losing streak.
- Review and learn: Regularly analyze your trades to refine your strategy.
Test your risk and money management skills with virtual funds—no real money at stake. Once you find a strategy that you feel confident about, you may consider moving to a live account.
Free trading tools and resources
Remember, you should have some trading experience and knowledge before you decide to trade online. You should consider using the educational resources we offer like NAGA Academy or a demo trading account. NAGA Academy has lots of free trading courses for you to choose from, and they all tackle a different financial concept or process – like the basics of analyses – to help you to become a better trader.
Our demo account is a great place for you to learn more about leveraged trading, and you’ll be able to get an intimate understanding of how CFDs work – as well as what it’s like to trade with leverage – before risking real capital. For this reason, a demo account with us is a great tool for investors who are looking to make a transition to leveraged trading.
