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Not all traders are created equal and what may work for somebody else in terms of how much money to allocate per trade, may not work for you. What you may consider “risky” could be perfectly tolerated by another investor. Risk perception is subjective, but understanding the principles of risk management can help you determine the right amount of money you should be investing per trade, according to your risk tolerance. When a trade size gets too big for your liking, risk begins to outweigh the potential reward.

Imagine you need to cross a canyon to get to a beautiful waterfall just on the other side. There is a narrow wooden hanging bridge that gets you across, and a few kilometers away, there is a two-lane concrete bridge. They both get you to the other side, but you are right in front of the narrow hanging bridge so that would get you across the canyon quicker. If it doesn’t fall. Or if you don’t have a panic attack on the way. Some people may choose to get across using the narrow hanging bridge and they are perfectly comfortable with the risk, while others would prefer to take the longer way and cross the canyon on the more solid bridge, even if it takes them longer. Trading works the same way. If you are comfortable with the risk of investing a larger percentage of your capital on one trade, you may get to make more money quicker. Or lose it all quicker as well.

Having a formula to manage your risk, according to your risk tolerance, is one of the most valuable things you can do as you in your trading career. So how should you determine which bridge you should walk on, you ask?

The first thing you need to determine is what percentage of your money you are willing to put at risk on each individual trade. If you know how much money you are willing to lose on a trade, prior to entering it, your level of stress will significantly diminish. Experts recommend assigning anywhere between 1 and 3% of your account’s equity to each trade. Keep a journal of your trading activity and update your account’s equity each time you open a new trade.

Once you’ve determined how much money you feel comfortable putting at risk, the second thing you need to do is determine where you want to set your stop loss levels in terms of pips, meaning an area where the system will tell you that despite all your good intentions, you were wrong.

Now that you have your acceptable risk as a percentage and your stop loss level determined, you can calculate the best trade size based on pip-based exit, or maximum value per pip. Take your account balance, multiply it by your acceptable risk %, and divide it by the stop loss distance (in pips) and you’ll get your maximum acceptable value per pip.

Wherever you set your risk tolerance and whatever trade size you decide is good for you, make sure you are consistent with your risk percentage. There is no trade so awesome to merit increasing your risk level and deviates you from your risk management strategy.