Have you ever heard of someone blowing an account?
Its a term traders have used to describe what happens when their trades get closed out due to their existing capitol matching their total unrealized losses.
What that basically means is that they entered too many positions or too large of a position and the trade started to go in the negative. The trade continued to go into the negative to where the total losses matched the total account value.
When this happens the broker being able to see your account notices that you only have $1000 in your account total but are $998 in the negative on a trade that you had taken a large position on. Since the broker does not want to close the trade using any of their own money they will close your trade out. This can happen at anytime when you are getting close to your margin call.
So the broker closes you out on the trade and sends you a kind email informing you of the damages. When you open up you broker to check the progress of your account you notice that what you were trading had made the move you had anticipated to happen but of course after you had been closed out by the Broker.
This is a mistake that many new traders have made as they are rushed to try and make profits. They are not entering the market with the idea of building consistency and developing a skill but more in looking to make a quick buck. This kind of mentality in the market will potentially expedite the speed at which your account gets blown.
If you look on other websites you see people celebrating having their accounts closed out do to losses. They see it as a rite of passage towards becoming a successful trader. In reality you don’t need to start off with poor trading habits to fail to then learn the right ones. Starting off with the right tools and habits right from the beginning just sets you up to be ahead of the learning curve.
Take it from professionals, who have had to struggle through trial and error to learn from their mistakes. Now the real question is how to prevent my account from getting closed out. I mean I could tell you “Don’t loose money” but that doesn’t really help you in terms of a strategy or a system that you can have in place to ensure that you are able to mitigate the risk exposure.
For the examples that we are going to talk about lets say that you have an account of $5,000. You funded the account and set it up and you are now looking to start your trading.
Trading with a 2% risk rule is designed to ensure that you are not holding on to large losses wishing that they decide to turn in your desired direction. The idea of trading is to stay in the game as long as possible. The longer you are in the game the better the effects of compound interest take place. This is where you capitol begins to start exponentially growing overtime.
To be able to get to where you are proficient in trading you are going to need to practice and take a few trades. Preferable you are taking your first couple of trades in a demo account. If you are not sure how to set one of those up please do let me know and I would be happy to help.
To maintain a 2% risk profile we need to close out any trades when the assumed losses become 2% of the total account value. So if you are in a trade that used let’s say $600 of capitol of your total $5,000 account size.
Over time depending on what type of market you are trading there is a potential that the asset you are trading could drop in value. Since we are following the 2% rule the most we are willing to risk in losses on this trade should it go against our trade direction is $100. ($5000 X 2% = $100)
Which means your actual trade that you have opened your trade would need to go a total of close to 17% in the negative before you close out this trade. This still gives you plenty of room to be able to experience some natural draw back or retracements that can occur in the market without being closed out.
Using a stop loss is going to ensure that you maintain in control of your risk. Placing it at the strike price to where should it meet that price your maximum risk is 2% is they key to being able to take out a majority of the stress out of trading. Most individuals stress because they are constantly watching the charts glued watching every single tick up and tick down.
When you have conducted appropriate analysis or used the accurate tools to help come up with your trade plan that includes a definite take profits point and stop loss then you should not have anything to worry about. You should allow the trade its time to make the appropriate move it needs to make. Should it go in the direction of your trade then you secure the profits. In the event the trade goes against the direction of the market then we close the trade at either a small loss or a net loss and look for the next potential set up.
The important part of this skill is to not get emotional about every trade in hopes that the next one is your golden egg. Take each trade with intention and after having done your due diligence and create the complete action plan. With strong supporting details and an action plan that covers all the outcomes then you can effectively trade without the risk of having your account blown. This will help keep you trading longer and by default increase your success rate.
Should this trade get closed out after it break past your 2% risk, its is okay. You still will have $4,900 left in the account worst case scenario if you follow the 2% risk rule.
Following this rule and a few others have helped me stay focused and on track with my trading.
What are some of the rules you follow by for your trading?
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As always stay smart on your trading and manage your risk to keep your profits secure. Happy Trading my friends.