Hi, do you recommend any books, PDF articles, where to start studying risk management? It seems simple, but I think I need to study this topic in more depth. Thanks for reading
The absolute best book on "classic" risk management based trading system design is "Trade your way to financial freedom" by Van Tharp. Another one with a very good opening chapter on the psychology of risk management is (ironically) Jesse Livermore's book "How to trade in stocks", which also has some great tactics for doing well with stocks in general. The overlap between the methods presented therein and William O'Neill's system (CANSLIM) was pure gold! This last book is the only one I still have on the shelf. I make myself read it at least once a year.
Seeing as you are a beginner, it might be better to start, bottom up. There are MUCH MUCH more sophisticated models and what follows is VERY basic. That being said, it seems many retail traders don't even do these basic calculations. The priority is to not destroy your account so you can continue to learn and trade. Re-funding your account, is not a true solution either. So the two questions are: How much do you risk in any one trade? How many trades can you lose in a row? I.e. full risk per trade * number of trades. Here is an example: On the system side, It can have a maximum draw down of 2.5K per trade. There is a Stop-Loss at that point. It appears that the worse case scenario is 4 trades in a row without a winner. It has a daily maximum loss of 2.5K/contract. All positions are closed by 1:15 PT On the broker side: The Maximum loss in the account is set to 70% The Maximum numbers of contracts (futures) it can trade at one time is 3. So as a working framework: Acct Balance: $20,000 Broker Risk Setting: 70% At Risk: $14,000 Contracts: 3 Max Drawdown/Contact: 2500 Total Max Drawdown: $7,500 Risk Ratio: 54% (7,500/14,000) So this very basic (15 minutes of work) says to me it is OK to trade this system. Never mind the reward side, except to say the profit factor is over 2. So now I have a low probability of blowing my account because: Any one day will not do it. Any one trade will not do it The broker will shut down the account if I go over the estimate (53%) by another 47%. I am confident in a orderly market where MKT orders work and markets don't close preemptively, it should be OK.* This is so basic, but IMO, enough that I don't worry about it and I can concentrate on making the system better. I.e. it is not ideal, but tradable. Hope this helps. And by all means read up about it. But ultimately, keep it simple and focus on the trading after you know the big issues at least quantified. *In disorderly markets all bets are off, but that is why I want the ratio to be around 50%.
The Ultimate Trading Risk Management Guide (2019) Trading Risk: Enhanced Profitability through Risk Control (2004) If you have no previous exposure to risk management, go with the first one, which is catered more toward the beginner traders. Second one is pretty old and written in an academic format but quite solid, especially for those more into stats and math.
If you want to gain understanding of core mathematical concepts behind risk management (like markowitz portfolio theory, correlation, hedging strategies, etc.) I would recommend to read Hulls Options and Derivatives class book
I got a solid tip you might not read in a book. No matter how much money you have...be sure your first account is no more $10k...$5k might be even better. Starting out completely green never having any exposure to financial markets with zero guidance, a $100k account, and big dreams was probably my worst mistake.
Risk management is simple. You get a "read on your play", then determine how much you're willing to risk that your "read" is correct. That's where you place your stop. Don't complicate things. KISS!
Another angle is the need to learn to do it in the first place. It's so easy to hope the market will let you out of a losing situation if you just stay put and KEEP BUYING!