Therefore, we are confident that risk management will result in financial gain in the long run, but now we’d like to present the alternative.
What would happen if risk management guidelines weren’t followed?
Think of this illustration:
Say you have $100,000 and incur a $50,000 loss. How much of your account have you actually lost?
The solution is 50%.
Traders refer to this as a drawdown.
A drawdown is the loss of capital following a string of unsuccessful trades.
This is often determined by subtracting a relative capital peak from a relative capital trough.
Normally, traders record this as a portion of their trading account.
We are constantly searching for an edge in trading. That is the main driver behind the development of trading systems.
A trading strategy with a 70% profit margin seems like a pretty strong advantage to have. But does the fact that your trading strategy is 70% profitable really mean that you will win 7 out of every 10 transactions you make?
No, not always! How do you know which 70 trades out of the 100 will be profitable?
You don’t, is the answer. You might lose the first 30 consecutive deals before winning the following 70.
That would still result in a 70% profitable method, but you must ask yourself, “Would you still be in the game if you lost 30 trades in a row?”
Because of this, risk management is crucial. Whatever strategy you employ, you will ultimately go on a losing streak.
Even professional poker players who depend on the game for their livelihood experience terrible losing streaks and still turn a profit.
Good poker players control their risks since they are aware that they won’t win every tournament they enter.
Instead, in order to survive those losing streaks, players only stake a little portion of their whole bankroll.
You have to act in this capacity as a trader.
Drawdowns are part of trading
The secret to being a profitable forex trader is developing a trading strategy that enables you to endure these times of significant losses. Having risk management policies in place is also an element of your trading strategy.
So that you can endure your losing streaks, only risk a modest portion of your “trading bankroll”.
Recall that if you follow precise money management principles, you will eventually turn into the casino and “you will always win.”
We’ll show what happens when you utilize good risk management in the following part and what happens when you don’t.