How to Define and Scale Risk

Determining risk is essential for every trader. As soon as you take a position, your next move should be to set a physical or mental stop loss. Trading is tough enough. Setting risk relieves some tension and allows the trader to concentrate on profit potential and trade management.

Risk varies for all traders and may differ due to the time frame of the trade, account size, lack of conviction or fundamental reasons such as earnings or economic reports.

There are so many factors that can affect a trade. This is especially true during the pandemic where volatility is high and erratic swings are frequent, week in and week out. This makes defining risk even more difficult. Consequently, having a methodology is imperative.

The art of defining risk must include current volatility. I refer to recent average ranges, or ATRs, to set profit potential and risk. They allow me to be consistent with risk/reward ratios.

For benchmark averages I use 14-day, 9-week, 7-month and 5-quarter ATRs. A speculator or swing trader should focus on day and week ATRs. If you prefer longer-term trades use month and quarter ATRs to set risk and profit targets.

For example, for a bullish swing trade, I follow these rules:

  • Entry price plus 0.5 average day range (ADR) equals target 1 (T1). Risk is set at 0.75 ADR.
  • If ADR is realized, then move risk (stop) to entry. At this point your trade will be a wash if it reverses.
  • Target 2 (T2) equals an ADR (avg day range). If that is reached, risk moves to T1. At this point you are locking in profit.
  • The next target (T3) is 0.75 of an average week range (AWR). If that is realized, risk moves to target 2, thus locking in more profit.
  • T4 is the goal for a swing trade and that equates to an average week range. At this point scaling risk is best. Setting stops by a sliding percentage should help squeeze more profit out of the trade. When T4 is hit, a 0.5 ADR trailing stop will keep you in the trade and possibly squeeze more profit as the market moves in your favor.

John Seguin, Market Taker Mentoring

Trader Education