10.2 What is Risk Capital?

Additional Reading About What is Risk Capital

What is Risk Capital - Text Version

In this lesson, we are going to talk about risk capital, what it is, and how you should handle it. 

You have made that all-important decision to trade with real money and you are finally ready to deposit funds into your trading account. 

This is the start of what will hopefully be a long and fruitful journey into the markets. It’s an exciting time. When you have real money on the line, you can call yourself a trader.

At this point, you must ask yourself a very important question. Is the money you have decided to trade with, truly considered risk capital?

And what do those words “risk-capital” even mean? 

Defining risk-capital doesn’t come from a formula or a spreadsheet somewhere. It comes from asking yourself a couple of very tough questions. These questions are part psychology and part financial life. That means the answers are completely personal to you. You can’t take someone else’s version of risk-capital and automatically think it will be the same for you.

Let’s begin with those tough questions.

Question 1.

Can you afford to lose the capital you have chosen to risk in the markets? Really afford to lose it? Close your eyes. Imagine your account goes down to 50% of its initial value. Or it goes to zero. How has it affected you? Your lifestyle? Your family? Can you still pay the bills? Can you continue to support anyone you need to support? If the answers to either of the last two questions are “no”, then you are not trading with risk-capital. You are trading with money you cannot afford to lose.

Now let’s be clear. Even if you can afford to lose it, it can still be painful to lose a big percentage of your trading account. In truth, it should be painful – the pain serves as an important warning sign that something is wrong with the way you trade and that something must change if you are going to continue. It must be turned around. No trader should be mentally indifferent to big losses in their account. But you should always be able to afford to lose.

Question 2.

If you lost your trading capital, how long would it take you to save it back up? If your answer to this question is “it would take me too long to save it back up one day” then you are very probably trading with too much money on the line. What’s too long? 6 months? 1 year? 5 years? Well, you must decide that for yourself.

What happens to traders who trade with money they cannot afford to lose? They get panicked by a single loss or a string of consecutive losses. They hold on to a losing trade in the hope that it will turn around only for the loss to get bigger, thereby creating a bigger problem. When a trade is in profitable territory, they get out too early because they cannot afford to see that profit disappear, even though to be profitable means letting your trades run to their proper targets. They do not control their decisions based on strategy but instead on fear of what a potential loss in their account will have on all other parts of their lives. It’s financially dangerous.

Be intelligent. Start your trading career on the right foot. Trade ONLY with risk-capital.

In the next lesson, we are going to talk about how much money you should risk per trade.