Session 02 · 4 min read
Risk Management
The sizing rule that decides everything, the arithmetic that makes deep losses so expensive, and how to judge a strategy by expectancy instead of by its last trade.
Every other session teaches you how to find and time a trade. This one teaches you how to survive being wrong, which happens to everyone, forever. Risk management is what decides whether you are still trading a year from now.
The non-negotiable rule
Risk no more than 1–2% of your account on any single trade, and measure that risk with your stop distance — the gap between entry and stop — not with position size. Two trades of identical dollar size carry wildly different risk if their stops sit at different distances.
Worked through: a $10,000 account risking 1% can afford to lose $100. Entry at $50 with a stop at $48 puts $2 of risk on each share. $100 ÷ $2 = 50 shares. The size fell out of the arithmetic — it was never a matter of how much cash was sitting idle.
Stop first, size second
The order matters. Decide where the stop belongs based on the chart — the price at which your idea is simply wrong — then derive size from that distance.
Working the other way, from the share count you want back to a stop that happens to fit, lets your appetite place the stop. That stop has nothing to do with where the trade actually fails.
Why small losses matter
Drawdowns punish you twice: once when you take them, and again on the way back. Lose 10% and an 11% gain restores you. Lose 50% and you need to double what is left just to return to flat.
| Loss | Gain required to recover |
|---|---|
| 10% | 11% |
| 20% | 25% |
| 50% | 100% |
The climb out gets disproportionate fast. Keeping individual losses small is not caution for its own sake — it is the arithmetic that keeps compounding available to you.
Not every setup earns full size
Your 1–2% is a ceiling, not a default. A setup matching your best-tested criteria exactly earns the whole allowance. A murky one earns a fraction of it. Nothing earns more.
| Tier | Risk | When |
|---|---|---|
| Full size | 1–2% of account | Your clearest A-setups, matching your criteria completely |
| Scale-in | Partial, added as confirmation builds | Developing setups that have not fully confirmed yet |
| Reduced | Half of normal risk | Countertrend trades or setups where the picture is unclear |
| Asymmetric bet | Well under 0.5%, strictly optional | Low-probability, high-payoff ideas you want small exposure to without real downside |
Being right vs staying solvent
Being right feels good. Still having capital next month matters more. Capital preservation is the actual job — not calling every move, and not proving a point. The market has no opinion about whether you were right on a trade you sized too large to survive.
Expectancy and R
R is your initial risk on a trade — what you stood to lose at the stop. A trade that makes double its risk is +2R; a trade that hits its stop is −1R. Thinking in R puts trades of any size on the same scale.
Expectancy is what actually decides whether a strategy makes money: (win rate × average win) − (loss rate × average loss).
This is why a 40% win rate can be very profitable. With +2R winners and −1R losers, (0.40 × 2) − (0.60 × 1) is positive even though you lose six times out of ten. A strategy does not need to be right often; it needs its wins, weighted by size, to outrun its losses.
Exits: where a stop belongs
Put the stop where your idea is disproven — just beyond the structural level that would invalidate it. A stop at $48.00 because the number is tidy tells you nothing about the trade. A stop beyond the level tells you exactly when to admit you were wrong.
On the way up, scale out or trail behind structure as the trade works. Never widen a stop once it is set. Moving it away to avoid booking a loss is the standard route from a small planned loss to a large unplanned one.
Write your own rules
Principles are easy to agree with and easy to abandon. Written numbers are what you actually follow under pressure. Write your own version of each of these:
- A maximum daily loss that ends trading for the day once it is hit.
- A cap on concurrent open positions, so risk cannot quietly stack across several trades.
- No adding to losers — a losing position is not an invitation to average down.
- A journal entry filed before the next trade is placed.
Do this today
Write your risk rules down with the specific numbers that fit your account and your temperament. A rule you can point to is far harder to talk yourself out of than one you only meant to follow.
Core principle
Risk management is not about avoiding losses. It is about guaranteeing that no single loss, and no run of them, can end your ability to keep trading.
Put it into practice
Reading builds knowledge; journaling builds skill. Track your trades and see your own patterns.
Start your free monthThis content is for educational purposes only and is not financial advice. Trading involves substantial risk of loss. See our risk disclosure for details.