If trading success were measured as a complete 100%, risk management would account for at least 20–30% of that success. It’s that crucial.
Every time we take a buy or sell position in the market, we're taking a risk — we could lose the money we put into the trade. This is the reality of trading. Yet, many traders — myself included when I started — tend to overlook the downside. We focus too much on the potential rewards and not enough on the possible losses.
Your downside is the most important factor in your long-term survival as a trader. If you don’t protect it, you’ll quickly be out of business — and likely walk away believing trading is a scam.
Let’s take a simple example:
Suppose three traders A, B and C each have a $1,000 account and spot the same buy opportunity on EUR/USD. The trade offers a 3:1 reward-to-risk ratio. One trader aims to make $600, another $300, and the third just $100.
- To make $600, Trader A needs to risk $200 (600 ÷ 3)
- To make $300, Trader B needs to risk $100 (300 ÷ 3)
- To make $100, Trader C only needs to risk around $34 (100 ÷ 3)
If the trade is successful:
- Trader A gains 60% (new account balance: $1,600)
- Trader B gains 30% (new account balance: $1,300)
- Trader C gains 10% (new account balance: $1,100)
- Trader A down to $800
- Trader B down to $900
- Trader C down to $966
Losing Streak |
Trader C (3.4% risk) |
Trader B (10% risk) |
Trader A (20% risk) |
|---|---|---|---|
| 0 | $1,000 | $1,000 | $1,000 |
| 1 | $966 | $900 | $800 |
| 2 | $933 | $810 | $640 |
| 3 | $901 | $729 | $512 |
| 4 | $870 | $656 | $409 |
| 5 | $840 | $590 | $327 |
| 6 | $811 | $531 | $261 |
Clearly, Trader A has the steepest drawdown — their account has been slashed by nearly 75%. Trader B’s drawdown is significant, while Trader C, though not unscathed, is in a much better position.
This is where trading psychology steps in. If Trader A, frustrated by their losses, decides to increase risk to make back the money quickly, their account could deteriorate even faster. This is a common trap for new traders — it happened to me, and I can almost guarantee it may happen to you too, if you don’t manage risk properly.
Recovering from losses is much harder than most traders realize. After 6 losing trades:
- Trader A would need to make a staggering 285%
- Trader B needs to make about 89% of their current balance to return to $1,000
- Trader C needs just 24%
This example is simplified to drive the concept home. In real markets, no two traders execute systems the same way. Even with identical strategies, differences in discipline, mindset, and emotional control can lead to drastically different outcomes. Some systems also experience larger drawdowns or lower reward-to-risk ratios, further compounding losses when risk is not carefully controlled.
Losses are part of trading — sometimes even several in a row. The severity of your drawdown and how you respond mentally are key to your recovery. Smaller losses are easier to stomach and recover from, both financially and psychologically. On the other hand, taking bigger risks may look appealing because of the higher upside, but the cost during downturns is often devastating.
So, before you crank up your risk to chase bigger profits, remember this: recovering from a loss is much harder and more expensive than slowly and consistently stacking small, smart wins from the market.
