Financial Risk would include any losses occurred from trading. Continued losses will lead to account depletion which can be in of itself, a major psychological hurdle to overcome.
Another type of financial risk would be when a trader is under major pressure to cover their living expenses. This type of scenario is not recommended and will again, put huge pressure on the trader. Going into the market each day with a dollar amount they “must” make to pay the bills is a very difficult proposition. One of the most important aspects to trading successfully is approaching the market with an objective perspective and focusing on the process of trading rather than trading for dollars. When one focuses on the result, the process gets forgotten and mistakes are commonly made. This soon becomes a self-destructive cycle and typically ends badly.
Being under-capitalized is another financial risk. One of the most common mistakes traders make is that they trade a market that is simply too big for their risk. Generally speaking, you want to risk at a maximum 3% – 5% of your account equity per trade. The variable issue is that risk in of itself is not a static reference. Risk changes based upon the respective market’s volatility.
Here’s an example of what I’m referring to. Let’s say someone with a $10,000 trading account would like to trade 3 contracts in the ES. The average true range for the ES is currently 15.40 points on a rolling 5 day average. That’s a fairly wide range. With that increase in volatility, the structural references to base our risk upon begin to widen. In this example, let’s say that the average stop placement is 3.00 points. This equates to $150.00 per contract. If we’re trading 3 contracts, that equates to $450 for the trade or roughly 4.5% – 5% of your account’s equity. This will provide you definite limitations as this is only the average points risked. There are certainly scenarios that call for 4 points or 5 points risked. That will be far above this $10,000 account’s threshold for risk and that individual would need to pass on the trade (if they’re smart). But the opportunity may have been three times that.
So the point here is to make sure you’re trading the market that fits within your account’s risk threshold.
The last piece regarding financial risk would be operating under a high overhead structure. What I mean by that is being scratch at best with your trading and using a trading platform that is costing you more than what your business is providing. Like any business overhead is crucial to the success of that business. Too high an overhead in the beginning reduces the chances of success. Please note that there are minimums to conducting sound business and there are certain essentials I feel traders must have to have any chance of success which I will go into later.
Some typical high overhead issues would include the following:
Premium Cost Trading Platform(s) and Charting
High Broker Commissions (above industry average)
Premium News Service Providers
igh Educational Subscriptions
High Office Lease
With that being explained, there are in my opinion industry standards or minimum costs to conduct sound business. You absolutely need an accurate and stable trading and charting platform. You need an accurate data feed. You need high speed internet. I could go on but its important to keep that in mind. If your background is not in finance and you did not receive any sort of training in trading, you need to educate yourself somehow. You pay for what you get but there is a minimum to this business to have any chance of success.