Risk management is the practice of controlling the size and likelihood of loss, protecting capital and preserving the ability to trade tomorrow.
It is the combination of rules, sizing, timing, and psychology that turns isolated wins into a lasting edge. Below you'll find the full educational master-class: definitions, detailed guidance, deep dive toggles, and a downloadable one-page checklist.
Preserve capital
Without capital you cannot continue — prevention of ruin is the principal aim of risk rules.
Build discipline
Rules remove emotion and standardise decision-making across different market conditions.
Measure edge
Risk rules allow a small statistical edge to compound while limiting the downside.
Core Definitions
Pips • Risk-to-Reward • Lot Size
What is a Pip?
A pip (percentage in point) is the standard unit for measuring price movement in forex. For most majors 1 pip = 0.0001; for JPY pairs 1 pip = 0.01.
Pips standardise distance across pairs and allow consistent stop and target placement.
Example: EUR/USD 1.1000 → 1.1040 = 40 pips.
Note: pip value depends on quote currency and contract size; treat "pips" conceptually for non-FX instruments.
For USD-quoted majors, one standard lot (1.0 lot) typically equals roughly $10 per pip. But pip value varies by quote currency and lot size:
• USD-quoted majors (EURUSD, GBPUSD): $10 per pip at 1.0 lot.
• JPY pairs: pip size is 0.01 and the dollar value must be converted by pair price.
• For indices, commodities and crypto there is no 'pip' standard; instead use the instrument's point/contract value (e.g., NAS100 points).
Traders should consult contract specs or a pip-value reference when trading non-standard symbols. The difference matters for precise position sizing and risk calculations.
What is Risk-to-Reward (R:R)?
Risk-to-Reward compares potential loss to potential gain. If you risk 1 unit to make 3, that's a 1:3 R:R. Combined with your win-rate, R:R defines expectancy and determines if a system is profitable over time.
Trade selection: a higher R:R typically needs fewer winners to be profitable, but higher R:R targets may reduce hit rate.
The practical art is matching R:R to your strategy. A scalper might run many 1:0.6 trades with a high win-rate; a swing trader might target 1:3 with a lower win-rate. Both can be profitable if the combination yields positive expectancy.
Example: if your win-rate is 40% and your average R:R = 2, expectancy = 0.4×2 − 0.6×1 = 0.8 − 0.6 = 0.2 (units of risk) → positive. That means over time you expect +0.2 per trade of your risk unit.
Do not pick arbitrary R:R targets — study how your setups historically achieve targets and base expected R:R on real data from your journal.
How to Think About Lot Size
Lot size sets your exposure. The same stop distance with a larger lot will increase dollar risk. A consistent sizing rule is the primary tool to control drawdown and avoid ruin.
Rule of thumb: risk a small, fixed % of your account per trade (0.25%–1% for most traders).
Why: small percentages preserve capital through streaks and maintain compounding opportunities.
Professionals combine percent risk with position limits: "max % per trade", "max exposure per instrument", and "max daily realized loss". They also scale positions (pyramiding) only within documented rules.
If your account is $10,000 and you risk 0.5% per trade, your dollar risk per trade is $50. With a 40-pip stop, you would size the position so that 40 pips = $50 (convert pip value to determine lots).
Importantly: never increase size to try to recover losses — compounding with consistent small risks wins long term.
Critical Execution
How to Set a Stop Loss — Advanced Guidance
Where to place stops (practical rules)
The stop-loss should mark the point where your trade idea is invalid. Setting stops logically prevents arbitrary "hope-based" exits and limits losses to planned amounts.
Volatility-based (ATR): use 1–3 × ATR to avoid normal noise; adjust for session volatility.
Percentage-based: set a stop that limits dollar loss to a fixed % of equity (for strict money rules).
Many losing behaviours stem from poor stop discipline: moving stops wider to avoid losses or removing stops entirely. To avoid this, write explicit rules before entry: where the stop is and the reason for that level. If you plan to break-even after partial profit, document the conditions (e.g., price reaches 0.8R and volatility is stable).
Consider slippage and spread: around news and low-liquidity times, effective stop distance should be larger or the trade avoided. Always account for the worst-case scenario — if a stop executes at a worse price, understand how that affects your risk.
Example rule set: stop = structure + 0.5 ATR; size so dollar risk ≤ 0.5% account; if daily realized losses exceed 2%, stop trading for the day.
Order Entry — What to fill
When entering a trade in most platforms you can specify stop loss as:
Price level (exact price where to exit)
Distance (pips from entry)
Monetary amount / percentage (some brokers support this)
Best practice: decide stop format before entry and document in your journal for post-trade review.
Performance Map
Risk-to-Reward vs Win Rate — Profitability Map
At-a-glance: Is your system viable?
Use this table to judge whether a given combination of win-rate and R:R is, mathematically, Profitable / Breakeven / Losing (qualitative). This helps you match strategy style to realistic targets.
Win %
1:0.5
1:1
1:2
1:3
1:5
Legend:Profitable • Breakeven • Losing
The table is a simple mathematical categorisation: Expectancy = WinRate × RR − (1 − WinRate) × 1. If Expectancy > 0 the cell is Profitable; = 0 → Breakeven; < 0 → Losing.
Example 1: 20% win-rate at 1:1 → Expectancy = 0.2×1 − 0.8×1 = −0.6 → Losing. Relying on 1:1 trades with such a low win-rate will destroy the account over time.
Example 2: 20% win-rate at 1:5 → Expectancy = 0.2×5 − 0.8×1 = 1.0 − 0.8 = 0.2 → Profitable. This is why strategies targeting large R:R can survive low hit rates.
Use this map to set realistic requirements for your trade selection and to reverse-engineer required win-rate for your target R:R.
Masterclass
Deep Dives — Volatility, Correlation, Psychology & Journaling
Why volatility matters
Volatility determines how far price typically moves in a session. For stop placement, use a multiple of the ATR (average true range) to avoid being stopped by noise.
A low-volatility strategy requires tighter stops and therefore more precise entries; a high-volatility approach requires wider stops and smaller sizes. Professionals calibrate stop distance to target and edge.
Liquidity affects execution: less liquidity near market open/close or around holidays increases slippage and spread. When liquidity is thin, your effective cost per trade (spread + slippage) increases — this must be included in your expected loss.
Rule: either widen stops to accommodate or reduce size/skip trades during low-liquidity events.
Example application: If ATR is 30 pips and you target a 1:3 R:R, you might set stop 1×ATR (30 pips) and target 90 pips; size so 30 pips = your risk % dollars.
Managing multi-position risk
Running multiple trades that move together (e.g., EURUSD and GBPUSD) increases portfolio risk. Simple sum-of-risk underestimates true exposure when correlations are high. Institutions measure correlation matrices and cap correlated exposure.
Practical steps: limit the total % of capital exposed to a single macro theme (e.g., USD direction); offset exposures with hedges; or reduce size when multiple correlated trades are open.
Example: if you have 3 EUR crosses all long, a EUR-drop could hit all simultaneously; cap exposure so that combined loss if all stops hit does not exceed your daily or weekly maximum drawdown rule.
Controlling the human factor
Psychology is the true risk. People deviate from rules when feeling fear or greed. Common patterns include: revenge trading after a loss, size escalation after wins, and stop-moving to avoid admitting a mistake. These behaviours compound risk faster than strategy flaws.
Concrete rules to defend against psychology:
Pre-commit: write the trade plan (entry, stop, target, risk) and only trade if conditions match.
Trade limits: max trades per day, max % risk per trade, max daily loss threshold where trading stops.
Cooling period: if you make consecutive losses or emotional trades, stop trading for the rest of the day and review a journal entry.
Build habits: sleep, exercise, scheduled breaks, and a fixed pre-session checklist. Small physical routines reduce cognitive fatigue and improve adherence to rules.
How to measure your edge
A trade journal must include: date/time, instrument, timeframe, setup reason, entry price, stop, target, lot size, R:R, outcome, slippage, and emotional notes. Without consistent data you cannot determine if an approach is profitable.
Metrics to track monthly: win-rate, average win, average loss, expectancy, win/loss streaks, max drawdown, and profit factor. Expectancy over samples of 100+ trades is more meaningful than small-sample P&L.
Use journal analysis to identify the setups that perform best, then allocate more capital to those while reducing or discarding poor-performing setups.
Tools
Download — One-Page Risk Management Checklist
Download the detailed, printable one-page Risk Management checklist (created for Reasoned Trading). Keep it with your journal and use it before each session.
Most retail traders start at 0.25%–1% risk per trade. Lower risk increases survivability and supports steady compounding. Institutional traders often use smaller percentages combined with leverage constraints and risk committees.
Choose a level that keeps you emotionally comfortable and stick to it; adjust only after documented strategy improvements.
Do I have to use R:R of 2 or more?
No — profitability depends on the mix of R:R and win-rate. A system with a high win-rate can profit with low R:R. The critical thing is positive expectancy over a robust sample.
Use the R:R map above to check whether your target R:R & historical win-rate produce positive expectancy.
What if I keep moving my stops?
Moving stops typically increases losses and destroys expectancy. Instead, document partial-exit plans and fixed rules for moving stops (e.g., after N pips in profit or after specific price action confirmation).
Disclaimer: All content is for educational purposes only and does not constitute financial, investment, tax, or legal advice. Reasoned Limited and its contributors are not registered financial advisers or broker-dealers. Trading involves significant risk and may result in the loss of capital. Past performance does not guarantee future results. You are responsible for your own trading decisions. By using this site, you agree to these terms and acknowledge that you should consult a licensed financial professional before making financial decisions.
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