Risk management is the process of deciding in advance how much uncertainty and potential loss a trading plan can tolerate. The video introduces the risk–reward ratio as a way to plan a trade. A ratio can help compare a proposed entry, exit and position size, but it does not predict price direction or guarantee a profitable result.
What the risk–reward ratio measures
The risk–reward ratio compares the amount that could be lost if the planned exit is reached with the potential gain at a chosen target. For example, if a plan risks 100 units to target 200 units, its planned ratio is 1:2. Actual results can differ because prices may move past an exit, fill at a different level, or incur fees and slippage.
Plan the trade before choosing its size
- Define the conditions that would support an entry.
- Set the price or condition that would invalidate the idea.
- Estimate the possible loss per unit, including contract multipliers and trading costs.
- Choose a position size that keeps the total planned loss within a risk limit you can tolerate.
- Set an exit or review rule for a favorable move, while recognizing that a target may not be reached.
Why a favorable ratio is not enough
A trade with a large potential reward relative to its planned risk can still lose. A system’s outcome depends on the distribution of wins and losses, execution, fees, market conditions and whether the rules are followed. A high reward-to-risk ratio does not compensate automatically for an extremely low success rate, and a high win rate alone does not make a strategy safe.
Understand drawdown and recovery
Drawdown measures a decline from a previous account peak. Losses reduce capital, and recovering to the prior balance requires a percentage gain that grows as the loss deepens. Limiting the amount exposed on each trade may help control a series of losses, but it cannot remove market risk or ensure recovery.
Use stops with care
A stop order can help implement an exit plan, but the execution price may differ from the stop price in a fast or illiquid market. Some products can gap, and leveraged positions may be liquidated under broker or exchange rules. Understand the order type and the product’s liquidity before relying on a stop as a fixed maximum loss.
A simple pre-trade checklist
- What would prove the trade idea wrong?
- How much could be lost if the exit is reached or execution is worse than expected?
- Is the position size consistent with the account’s overall exposure?
- What fees, leverage, liquidity or overnight risks apply?
- Does the trade still fit the written plan after a loss?
This is general educational information, not a recommendation to buy or sell any asset. A risk plan cannot make a trading strategy profitable or eliminate losses.