Forex Risk Management: A Lesson From A Hedge Fund Legend

“If you do not manage the risk, eventually they will carry you out.”

Larry Hite has an extraordinary CV.

He was an actor, a screenwriter and a rock band promoter.

And a successful hedge fund manager to boot.

He has a phenomenal track record of managing risk in the markets.

He’s retired now, and manages his own money. But he ran a hedge fund (Mint Investment Management Co.) for 13 years and achieved a compounded return rate of over 30%.

There aren’t many in the industry that can boast performance like that. When someone with that sort of record speaks, we should prick up our ears and listen.

I first came across Larry Hite’s interview with Jack Schwager in the Market Wizards series about 10 years ago. I was so intrigued by his obsession with risk management, I immediately re-read the interview, twice. Until that point, I’d never come across anyone who spoke about handling trading risk in the same way Larry did.

He mentions risk 36 times in the 7 page piece.  If you haven’t read the interview, you should. It could totally reframe how you think about your forex risk management.

Just in case you haven’t got a copy of Market Wizards within easy reach, I’ll give you a sneak preview of Larry’s main rule in trading:

Larry says the following:

“So the very first rule we live by at Mint is: Never risk more than 1 percent of total equity on any trade. By only risking 1 percent, 1 am indifferent to any individual trade. Keeping your risk small and constant is absolutely critical.”

It’s astounding the number of traders who ignore this rule or dismiss it as being nothing new.

Click here to start the challenge

A recent study found that significant number (28%) of young economics and finance professionals/students bust their accounts when asked to bet on coin flips.

Granted, that’s nothing unusual.

Until you realise that the coin flip they were betting on was rigged in their favour.

If you are betting on coin flips, over the long term, you’d expect to come out at roughly breakeven. Whether you land on heads or tails is a 50:50 chance. So the wins and losses should largely cancel each other out.

But what if the coin is rigged, and you know it’s rigged? What if you know that the coin will land on heads 60% of the time and tails 40% of the time

That’s a completely different proposition.

You’d just bet on heads all the time, and over a significant number of flips, you’d make money, right?

Well, for a lot of people that’s not actually the case, strange as that might seem. You can read the study and find out why.

So, what’s the lesson here?

It’s this: you can have a profitable trading strategy but still bust your account if you don’t pay due attention to position sizing and risk.

We just can’t afford to get complacent about managing our risk in forex trading. It really can be the difference between your success and failure in the market.

Most of the time, when our trading is not going as well as we would like, we respond by adjusting our trading strategy.

That’s not always the correct approach to take.

Often it’s risk management and poor position sizing that is the cause of poor performance. Your strategy might be completely solid, and it’s the sensible handling of risk that is the problem.

The optimal approach is to make sure that your risk amount bears some relationship to your account equity, and fluctuates in line with it.

So when you have more equity, you can take more risk.

When you have less equity, you take less risk.

As Larry mentions, if you don’t reduce position size when your account equity declines, you are massively increasing your risk:

In trading there are lots of things that are outside our control and knowledge.

We don’t know what economic numbers are going to be released, what a politician/central banker is going to say, when a terrorist attack is going to happen, when an adverse weather event is going to occur. What’s more, we never know how the market is going to react to an event or where it is going to go.

Here’s Larry again:

“The truth is that, while you can’t quantify reward, you can quantify risk”.

Really, when you think about it, one of the few things we have control over in forex trading is our risk and our position size.

That’s a massive mistake.

It doesn’t matter how good your trading strategy is. If your risk management is not up to scratch, you won’t survive. The market will shake you out at some point. You’ll blow up your account or endure a massive drawdown that didn’t need to happen.

At the end of last year, we decided that we got too many emails from traders who casually mentioned that they had blown up yet another account. It’s a massive problem among retail forex traders.

Too many traders are just handing their hard-earned money over to brokers on a plate.

Like this:

This is a huge problem.

But it’s actually easy to fix.

All you have to do is stick to Larry Hite’s advice. He’s a legendary fund manager after all; he has more experience than all of us here combined.

Risk 1% of account equity per trade – that’s all there is to it. It doesn’t need to be any more complicated than that.

Now, as traders, we know we like to tinker and adjust. We are all prone to breaking rules. Sticking to the 1% rule is probably easier said than done in the real world. The temptation, in the heat of the moment when the market is open and moving, is act quickly and not bother working out the exact position size required.

In real life, we’re far more likely to just type a lot size into the box quickly, just to hurry up and get the trade open, right?

So to solve this problem, and to help reduce the number of bust accounts in the industry, we created a piece of software.

It’s called the Forex Useful MT4 Risk Manager…

It’s a piece of software that helps you make sure you manage your risk like the professionals do.

You simply preset the amount per trade you want to risk per trade in advance.

The MT4 Risk Manager will calculate your lot size automatically for you, based on the amount you want to risk and where your stop-loss is going to be.

No more calculations are required.

It’s quicker, easier and more accurate than using the in-built MT4 “New Order” button.

If you keep your preset risk % constant, the amount you risk per trade will fluctuate in line with your account equity.

And if you keep it at 1%, you’ll be managing your risk exactly the same as how Larry Hite does it. If it’s good enough for Larry, a legendary fund manager, it should be good enough for us!

Have you ever blown your account slowly and steadily?

No, of course you haven’t. Traders bust their accounts by losing control and dramatically increasing risk.

The Forex Useful MT4 Risk Manager helps takes that option off the table.

Remember, before you can look to make gains in the market, you have to learn to preserve capital first.

Of course, there are more sophisticated ways to manage risk than what’s described here.

Different strategies may require different approaches for optimal risk management. Sometimes traders prefer to keep less of their trading capital on deposit with their broker for safety. That’s understandable.

But if you are at an earlier stage of your trading career, and you just want to be confident that you have got the basics right, a fixed % of account equity risk management strategy is a great place to start.

So if you want to be confident that your risk management skills aren’t letting your trading performance down, and be sure that you are giving yourself the best shot at success in the markets, the Forex Useful MT4 Risk Manager is an extremely valuable tool to have in your trading arsenal.

You can take comfort in that you’ll have no more unexpected, painful drawdowns, no more bust accounts, no more starting all over again.

That’s when you know you can start to get serious about your trading.

DISCLAIMER & COPYRIGHT

This update is based on my analysis on my charting package. It may differ to yours as it can be affected by time, market movements, charting packages and broker prices. I accept no liability for loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on any information in this report or analysis.