The Risk Tolerance in Trading


February 8, 2021 | AtoZ Markets – There are many possible pieces of the puzzle that traders put together to generate money in trading. And without a doubt, the most important general area is going to be money management. Paramount to money management is knowing one’s own risk tolerance in trading.

Definition

Before moving forward, traders should understand exactly what risk tolerance is when it comes to trading. It indicates the amount of risk that traders can tolerate per trade. It is quite different than money management, as money management concentrates on the ability to endure a series of losses. On the other hand, risk tolerance is more along the lines of the psychological capacity to receive a loss is measured.

This means that several traders are completely okay risking 3% on a trade, while others can only afford to risk 0.5% on the same setup. Above all, it is slightly a personal issue because every person and the individual trader will be different.

But a trader who knows he’s/she’s risk tolerance will ultimately be essential to success. If traders are not comfortable in their position, they might exit far too early. And worse, most of the time, when they find themselves in that position, their first analysis might be correct, and they jump out of the market based upon fear, not based upon anything substantial. Some things are worse than watching a position go in their favor after they’ve been scared out a little.

Knowing Risk Tolerance

Determining one’s risk tolerance is much simpler than what others think. To start with, traders must remember that understanding money management is crucial.

For example, you take a set up and risk 1% of the total account on the stop loss. Then, if you feel very comfortable in this position, that means you are well within the risk tolerance. A simple exercise to do is get up and walk away from the computer. Go on throughout the day and notice if you are overly worried about how the position is working out. When traders can go to work or somewhere else without checking the position frequently, they are absolutely within the risk tolerance.

For another trade, maybe you risk 2%. In that case, you see yourself more concerned about the trade and frequently check how it is working out. If it is bringing nothing but stress, it is definitely above your risk tolerance.

Measuring Risk Tolerance

Traders can try this simple exercise. Place a trade with 0.5% total risk on the stop loss. Then, traders must notice how they feel as they walk away from the computer and let the market do what it will. If it did not bother them, the next trade must be put to 0.75%, with the same parameters and the same observations. Thus, they just have to increase 0.25% every time they place a trade until they feel that it’s far too challenging to leave the market alone.

There are a few people who are willing to risk insane amounts of money, like 20%. And that is another conversation as it approaches money management. In money management, it states that trades must not be risking that kind of financial hit. However, by the end of the day, working in an acceptable range in looking where they can leave the trade alone to work out which direction will be one of the major steps forward in becoming professional traders.

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