How much capital should I risk on each trade?

I've been asked quite a lot of times about what money management and risk management systems I have in place as I work as an independent trader. It's an interesting point and in many ways, they are intertwined. I think the number one part about this situation is are you a trader or are you a person who wants to trade for a particular purpose, whether that's activity, enjoyment, some extra cash the “why” behind trading is the foundation of both money and risk management strategies. Many people jump into trading for quick gains or excitement but defining your purpose shapes your approach and determines what systems will work best for you.

 

If your purpose is to make steady income your risk management approach will likely be more conservative, focusing on minimizing losses and protecting your capital. This means being disciplined about position sizing, setting stop-losses, and avoiding excessive leverage. You’d probably also lean on systems that focus on steady, risk-adjusted returns rather than aiming for outsized gains.

 

On the other hand, if you’re trading for enjoyment or as a side venture, your tolerance for risk might be higher. You might take on larger or more speculative trades but still have a safety net in place. Money management is the framework that helps you decide how much of your capital to allocate to each trade, and risk management is about protecting that capital from significant losses. It’s the balance between ambition and caution that drives successful trading in the long run. The real skill is developing a system that aligns with your purpose and sticking to it, especially during the ups and downs of the market. There is a colossal difference between a risk management money management system that you would read about in a book and how the real world of trading works.

 

Money Management.

If you are embarking into the world of trading for the first time. The situation that you want to avoid is having to trade to make a certain amount of money and even worse in a certain amount of time. This is without doubt a recipe for disaster and failure. It just will not work. There are High Frequency trading (HFT) automated systems that trade on multiple markets, thousands of times a day that do make very steady profits, but they are hugely capital intensive and out of the reach of most individual investors. You need to be in a situation where you are relaxed, the funds that you have set aside for trading are unencumbered so that when you're looking at a trade, you're looking at the trade setup not thinking about the result of trade outcome. The minute trading becomes a lifeline for paying bills or fulfilling immediate financial needs, the game changes entirely. Under pressure, it’s easy to start second-guessing strategies, chasing losses, or taking on unnecessary risks—all of which increase the likelihood of losses.  

 In terms of your trading capital, you must appreciate that this is risk capital- if your method of trading is successful the capital will increase but in reality, there will be times where you go through drawdowns. Remember every trading day is slightly different from another- nothing is a certainty so results from even the best systems will have good and bad runs.

The amount of initial capital will differ from person to person. Clearly a trader who wants to commit only a short period of time to trading and not get too many positions will need a lot less capital than a person who wants to trade several hours a day with multiple positions in different markets. The length of time in the market also effects the capital requirement. Scalping strategies hold positions for short periods of time with usually tight stops and need a lot less capital than holding a position for several days where a much bigger stop and margin requirement will be required. It should also be noted that one of brokers primary revenue sources is charging for holding overnight positions. So, it is difficult to accurately know your initial capital until your trading structure is established. It is clearly best to have a plan and test out your plan to calculate that amount.

 

Risk Management

I have already alluded to various types of strategy where some thought must be given to your set up and the same applies to risk management of trades. One very important point about trading success is not to be fooled by taking up(purchasing) systems which promise incredible win rates- trading is not about winning 95% of the time – profit factor (total profits/total losses) is much more important. If you make 20 trades and win $1 on 19 but on the one you lose $40 your” 95% winning system” has a profit factor of 0.475 and is in fact a losing system! Anything above 1 is profitable and I prefer 2 and above!

Social media is rife with all sorts of systems that promise what seem highly attractive returns the reality is that many of claims are false. I did challenge one of the sites about their claims and the abuse I got was eye watering- most likely reason was that the game was up!

Another suggestion I would have especially when initiating a new trading concept is to keep stakes extremely low until you get a feel for how your market trades. Virtually all markets have their nuances, important in any risk situation is to assess the probabilities before committing significant capital. For instance, in trading the USA 500 the information that is critical as to how the market will trade includes

1. Futures opening/closing time
2. Cash market open/closing time
3. End of day Auction times
4. Significant economic or company news releases
5. Premarket/ post market equity trading times.

This list is not exhaustive but is all a part of the plan in terms of when to be in the market and when to avoid.

Once you have entered a trade the most important questions are when you will take profits and when will you exit if the market goes against your plan. The items I mentioned above quite often come in that calculation and are not the traditional I will enter the market at A and have a stop loss at B and a target 2x A-B.

Assuming that your trade plan is short term in duration then in general I would initially place a stop away from any “stop hunt “zone- (area targeted by short term Algos to find and trigger stops before immediately reversing) and then look to move my stop to break even as soon as you trade has moved in your favour effectively you have a “free trade”.

I am not really a great fan of simple trailing stops as natural waves in the market have a habit of finding whatever trail you have put in place. I much prefer dynamic stops where I manually move them usually after a reverse in the main trend has slowdown.

Finally, as you approach your target level, I will become much more aggressive in stop placement as there is nothing more frustrating than having a good plan a very good trade which misses your limit by a couple of points then reverses.

In conclusion there is no simple answer to the requirement needed for either your money/risk management hopefully some of the items I have mentioned above will be worthy of consideration. One last thought risk management is not just about money and markets but remember trading can be quite draining on the trader and it is easier to make mistakes if you are tired- taking a break is a most effective risk management strategy!