Limiting Losses

Risk management - I could not stress more the importance of this.

It is simply not possible for any trader - whether amateur, professional or anywhere in between - to avoid every single loss. The disciplined trader is able to accept losses without emotional upheaval. At the same time, however, there are systematic methods by which you can ensure that losses are kept to a minimum.

Every trader should employ a loss-limit system whereby he or she limits losses to a fixed percentage of assets, or a fixed percentage loss from capital employed in a single trade. Think of such a system as a circuit breaker on the trade. After a certain percentage has been lost from his or her trading account or principal traded, the trader may very well stop trading entirely or may immediately exit the losing position. With this system, exiting a losing position is an unemotional decision that is not affected by any hopes that "the market is sure to turn around any minute now."

A common level of acceptable loss for one's trading account is 2% of equity in the trading account.

Monthly Loss Limit of 6%

So, you have now established a system whereby your loss from each individual trade is limited to 2% of your risk capital. A general rule for overall monthly losses is a maximum of 6% of your portfolio. As soon as your account equity dips to 6% below that which it registered on the last day of the previous month, stop trading! Yes, you heard me correctly. When you have hit your 6% loss limit, cease trading entirely for the rest of the month.

Employing a 6% monthly loss limit allows the trader to hold three open positions with potential for 2% losses each, or six open positions with a potential for 1% losses each.