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Creating a Trading Plan (Part 3)

After establishing the trading mindset and trading goals, the next step in designing a trading plan is to focus on risk management and money management.

Risk Management and Money Management Plan

Risk management involves setting the size of risk on each trade, risk/reward ratio, profit probability, and position sizing. Meanwhile, money management focuses more on setting the size of risk against the overall equity account. Some questions that can help determine risk and money management are as follows:

  1. Do you consider risk factors very important?
  2. How do you determine the size of risk (or stop level), tend to be tight or flexible?
  3. How risky is your trading strategy? (accuracy of each trade combined with risk/reward ratio per trade).
  4. What money management approach will you use?
  5. What should you do when experiencing significant drawdown?
  6. What risks may arise from your broker and computer (hardware risks)?
Here are example answers that can help you understand how to manage risk and money management:

Example Answers:
  1. Risk Factors: I always consider risk factors very important; therefore, I am always cautious. I tend to trade in the short term with frequent entries and exits from the market because the longer I stay in the market, the more concerned I am about unfavorable outcomes.
  2. Size of Risk: I set tight stop-loss levels and not too high risk/reward ratios. Currently, I apply an average risk/reward ratio of 1:1. The size of the stop loss and target profit is relatively dependent on market conditions, averaging between 25 to 50 pips.
  3. Money Management: I risk 1% of my equity account on each trade I make. With an equity of USD 1000 and a 50 pip stop loss, I can trade with 2 micro-lots so that the total risk for 50 pips is USD 10 or 1% of equity. I use a fixed fractional approach, trading 0.01 lots per USD 500, increasing or decreasing it every USD 500.
  4. Drawdown Management: If experiencing a drawdown of 30% within the predetermined period, I will stop trading for a month and re-evaluate the money management approach I am using.
  5. Hardware Risk: In the event of hardware failure on my computer, I have backup data and another computer for trading.
Designing a strong and detailed trading plan will help you stay focused, disciplined, and organized in facing the market. By clearly understanding how to manage your risk and capital, you will be able to increase your chances of success in trading.

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