In this article, you'll learn about risk management when it comes to futures trading. With Drift's recent implementation of bracket orders, proper risk management has become much easier. Every trader should aim to understand the key concept of risk management before beginning on their trading journey.
As Bernard Baruch once said:
“In trading/investing, it’s not about how much you make but rather how much you don’t lose”
The fundamental concept behind risk management is to ensure that you "stay alive." As a trader, your primary objective is to survive in the market for as long as possible to capitalize on the opportunities the market has to offer. To achieve this goal, you need to minimize your losses, and the key to doing so is understanding proper risk management.
Risk tolerance is never a one-size-fits-all figure; but the common thread is ensuring that you don't lose more than you can afford. R is the terminology traders use in order to discuss their risk/reward ratio. Therefore, a 2:1R trade is when you stand to win 2 times the amount you are risking in a given trade.
In trading, if you lose 1% of your trading capital, you'll only need to gain 1% to get back to your previous account size. Conversely, the larger the drawdown, the harder it becomes to recover your losses. Suppose you lose 50% of your trading capital in a single trade; in that scenario, you'll need to earn a 100% return on your remaining capital to get back to your initial position. The deeper you dig yourself into a hole, the harder it is to get out.
Professional traders typically recommend risking between 1-3% of your total account value on each trade. This enables you to recoup your losses more easily if you encounter a losing streak.
It’s important to understand the implications of consecutive losses when it comes to risk management. For example, if you risk 1% on each trade and encounter five losses, you would be down by 4.9%. Conversely, if you risk 5% on each trade and face five consecutive losses, your loss would be 22.6%, making it significantly more challenging to recover.
This highlights the importance of minimizing your risk and avoiding digging yourself into a deep hole. The higher the risk you take, the more challenging it becomes to get out of a difficult situation.
Survival and incremental wins are the goals in the trading game, and an effective risk management strategy is essential. Take the time to understand risk management thoroughly and ensure you can make informed decisions to avoid unnecessary losses.
Start Trading On Drift
In case you’re new to Solana, check out some of our guides to help get you started on your DeFi journey.
- How To Set Up A Wallet To Trade On Drift
- How To Deposit & Withdraw Funds On Drift
- How To Transfer Funds From A CEX Onto Drift
- How To Bridge Assets To Trade On Drift
For more, head over to our Learn hub.
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Nothing in the text should constitute financial advice, Drift is not responsible for any losses that may occur by following the contents of this article. All content is provided here for educational purposes only.