Risk Tolerance VS Risk Capacity

To be successful at trading, long term, it’s extremely important that our risk tolerance is in line with our risk capacity.

Risk “tolerance” has to do with the amount of draw down we can withstand prior to the loss psychologically effecting our trading.

Risk “capacity” has to do with the amount of draw down we can withstand prior to the loss creating a real problem with our finances.

As a trading performance coach, I’m regularly coaching some traders to increase their risk tolerance while coaching others to bring their risk tolerance down to a responsible level.

Some traders have a very high risk tolerance. They will risk tens of thousands of dollars on a single trade without a bit of hesitation. On one hand this is fine because… IF they have the experience and financial capacity to absorb such a loss without it affecting their lifestyle, that’s how the game is played. On the other hand if their net worth is $100,000 then they have no business risking a stop loss of $20,000 on a trade. This would be way too much risk and could easily lead to financial ruin. Especially if they’re the type of trader who has trouble with exceeding their stops.

Other times I see traders that have a very low risk tolerance. They have plenty of capital yet can’t psychologically take the smallest loss. This is fine if they’re new and inexperienced but at some point, it’s time to pick up their game. Otherwise they’ll never make enough money to make trading worthwhile and eventually give up.

Your long term success depends on aligning your risk tolerance with your risk capacity. Make sure you know your net worth, your experience level and how much risk you’re able to take without risking financial ruin and then push your risk tolerance as far as you can without crossing that line.

For more information on dealing with risk, click here to learn about our Trading Triangle Program!

Make it a phenomenal day!

John Locke

Options Risk Diclaimer

No relevant positions

Leave a Reply