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Risk Allocation is a Very Important Part in Your Risk Management
Risk allocation is one of the subjects that not many people or educators talk about.
At least, they don’t talk about it in dept.
Risk allocation is a very important “tool” in your risk management toolbox and can increase your profits while reducing your drawdowns if used correctly.And this all, without even adjusting the trading strategy you use.
This article is an educational guest post, it was written by Cas Daamen, you can join his telegram channel
So, what is risk allocation?
It is how much risk you allocate to a certain trade or idea.
Most people just take a trade, risk 2% and that’s it.
But why?
Why risk 2% on that trade? They usually do this because that is what they have been told.
How can we allocate risk in a more efficient way, to maximize profits?
Have a trading journal?
You have to have a trading journal where you journal every single trade you take.
Journal all the different parameters of each trade.
I won’t go in dept about journaling in this blog, because then this blog will be 20 pages long, if not more.
The point of doing this is to find out what works, and what doesn’t.
To find out what connects your winning trades and what connects your losing trade.
If you find that after 100 trades, 70% of the winning trades have something in common that the losers don’t you can massively increase your payout.
For example, on 70% of these winning trades, there is a liquidity grab just before you enter your position, on losing trades this is not the case.
Let’s take a look at the chart to get a better idea of the example I just made:
Let’s say you buy the NZDUSD at the white arrow and target the liquidity at the blue box.
But, from your journal, you know that your chances of a winning trade increase with 10% when the lower white line has been broken, and price closed above it. This is a sign that the liquidity below the ranges has been used by bigger players to fill their buy orders.
Why then risk the same on both trades?
You know now what works better: taking trades where there was a liquidity grab before your entry.
Why then risk only 2% on something that has a higher probability of working?
It does not make any sense. You have to put all the odds in your favor if you want to succeed in this game. All the tiny bits help. When you know something has higher odds you have to push it. Be big in your best trades.
So, when you risk more on those setups and less on the once that don’t have this extra factor, you reduce your drawdown, as you risk less on the trades with lower probability, and you risk more on the ones that work better, increasing your payout.
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How to adjust your risk
Keep in mind that when you make these kinds of adjustments your sample size is big enough.
Meaning, don’t adjust your risk based on the last 5 trades. Go back over a few years of data, possibly 100’s of trades.
There is no hard and vast rule about this, as it depends on your trading style (day trading, swing trading, position trading, etc). But you get the point.
You can also apply this method if you use different strategies like I also do.
Risk more on the one that has a better expectancy and less on the one that has a lower expectancy.
You don’t change anything about the way you trade the markets, but your equity curve changes in a positive way, which is the goal.
So, if you don’t have a journal yet I strongly advise you to get one. Start logging all your trades. (winners & losers!) and analyze them afterward.
Risk Allocation the Bottom Line
Most traders don’t have a trading journal, and if they do take the time to journal, they don’t take the time to look back and learn from their journals.
Only a handful of trades does that, those are the ones that succeed.
So, the only way to succeed is to learn from your mistakes. If you don’t have a journal you don’t know what mistakes you make, and you will never learn.
Analyze your past trades and look for things that connect your winning trades.
Calculate differences in expectancy, strike rate & payout. Get the numbers.
Really dig deep and find out what works best, not based on gut feeling, but on statistics.
And then when you have those statistics, allocate risk according to these numbers, to the things that have the highest probability & payout.
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About the author:
My name is Cas Daamen and I’m from the Netherlands. I have been trading for roughly 3.5 years.
You might recognize my name, as I have written 2 more blogs on this website.
I really enjoy sharing my insights with other traders, that’s why I write these blogs.
I also like to connect with other traders, as I believe there is always something you can learn from someone else, regardless of where they are in their journey.
This game is already hard enough, so why do it on your own.
I do have a small telegram channel where I post insights in my trading almost every week.
I also post similar posts like the one above, so if you liked it, feel free to join my free telegram channel to learn more about my way of trading the markets.
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