Last Updated on 10 February, 2024 by Abrahamtolle
A trading strategy needs to have a positive expectancy, but you also need to manage risk to protect your capital. How do you manage risk?
We have conducted plenty of reader polls, and you find them all in our article about trading strategies statistics and facts.
What is risk?
We define risk as the possibility of losing your hard-earned capital. If you lose your capital, you need to make more than you lost to make it back.
The math is simple: if you lose 33%, you need a 50% return to get back to break-even. Thus, when you compound, you might have a better end result if you have smaller drawdowns than higher returns. This is why you need to understand the difference between arithmetic and geometric returns.
Volatility is a controversial measure of risk, but it does matter. The more volatility you have in your account, the more likely you are to make trading mistakes because we all traders are liable to trading biases.
If you commit trading mistakes you most likely suffer in the form of losing money. And how you handle a losing streak is important. And that is the real risk: to lose money.
To mitigate risk risk is not easy. We asked our followers on Twitter how they manage risk. We asked the following in the form of a poll:
How do you manage risk in trading strategies?
We gave the readers four options:
How do you manage your risk when #trading?
Please leave a comment for other options!
— Quantified Strategies – Only Facts And Statistics (@QuantifiedStrat) November 14, 2023
Unfortunately, Twitter allows only four options so the poll is limited.
However, we see that position sizing and diversification are most used. That is good. We believe these risk mitigations are the best options, perhaps even best by using both, or even a little bit of all four, even though we are no fans of stop-losses.
We are believers in trading strategy diversification. If you are unsure of what this means, we recommend reading our money, risk, and strategy management guide.