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skills/trading-plan-generator/references/risk_management.md

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+# Risk Management for Traders
+
+The single most important factor determining trading success.
+
+---
+
+## Why Risk Management Matters
+
+**The brutal truth:**
+- 90% of traders lose money
+- Most blow up their accounts
+- #1 reason: Poor risk management
+
+**What separates winners from losers:**
+- NOT better analysis
+- NOT better indicators  
+- NOT market prediction
+- **Risk management and discipline**
+
+**Your job as a trader:**
+- Protect capital FIRST
+- Make money SECOND
+
+---
+
+## The 1% Rule
+
+**Never risk more than 1% of account on single trade**
+
+### Why 1%?
+
+**Survival math:**
+- 10 losses in a row = -10% drawdown
+- 20 losses in a row = -20% drawdown
+- Still in the game
+
+**Compare to 5% risk:**
+- 10 losses in a row = -50% drawdown
+- Need 100% return just to break even
+- Likely game over
+
+### How to Calculate
+
+```
+Risk Amount = Account Size × 0.01
+
+Example:
+$50,000 account × 1% = $500 max risk per trade
+```
+
+### Position Sizing with 1% Rule
+
+```
+Shares = Risk Amount / (Entry - Stop)
+
+Example:
+- Account: $50,000
+- Risk: $500 (1%)
+- Entry: $100
+- Stop: $98
+- Risk per share: $2
+- Position: $500 / $2 = 250 shares
+```
+
+**Key insight:** Position SIZE changes, but RISK stays constant
+
+---
+
+## Daily Loss Limits
+
+**Hard stop when you hit daily loss limit**
+
+### Recommended Limits
+
+| Trader Type | Daily Loss Limit |
+|-------------|------------------|
+| Conservative | -1% |
+| Moderate | -2% |
+| Aggressive | -3% |
+
+### Why Daily Limits Matter
+
+**Prevents:**
+- Revenge trading
+- Emotional spirals
+- Blowup days
+- Tilt-induced disasters
+
+**Example:**
+- $50,000 account
+- 2% daily limit = -$1,000
+- Hit limit → DONE for the day
+- No exceptions
+
+### What to Do When Hit
+
+1. Close ALL positions
+2. Step away from computer
+3. Physical activity (walk/exercise)
+4. Review trades later (not now)
+5. Resume next day with clear head
+
+**Remember:** There's always tomorrow
+
+---
+
+## Maximum Drawdown
+
+**Stop trading at X% drawdown from peak**
+
+### Recommended Limits
+
+- Conservative: 10%
+- Moderate: 15%
+- Aggressive: 20%
+
+### When Hit
+
+1. **STOP trading immediately**
+2. Take minimum 1 week break
+3. Full trade review
+4. Identify systematic issues
+5. Paper trade only
+6. Return with reduced size
+
+### Why This Matters
+
+**Psychology of drawdown:**
+- -10% requires +11% to recover
+- -20% requires +25% to recover
+- -50% requires +100% to recover
+
+**Each % down becomes harder to recover**
+
+---
+
+## Risk:Reward Ratios
+
+**Only take trades with favorable R:R**
+
+### Minimum Standards
+
+**Conservative:** 3:1
+**Moderate:** 2:1
+**Aggressive:** 1.5:1
+
+### The Math
+
+With 2:1 R:R, you can be profitable at 40% win rate:
+
+```
+10 trades:
+- 4 wins × 2R = +8R
+- 6 losses × 1R = -6R
+- Net: +2R profit
+```
+
+### How to Calculate
+
+```
+R = Risk (Entry - Stop)
+Reward = Target - Entry
+
+R:R = Reward / Risk
+
+Example:
+- Entry: $100
+- Stop: $98 (Risk = $2)
+- Target: $106 (Reward = $6)
+- R:R = $6 / $2 = 3:1 ✓
+```
+
+**Rule:** If R:R < your minimum → SKIP THE TRADE
+
+---
+
+## Position Sizing Methods
+
+### 1. Fixed Dollar Risk (Recommended)
+
+**Same dollar risk every trade**
+
+```
+Shares = Risk $ / (Entry - Stop)
+```
+
+**Pros:**
+- Simple and consistent
+- Easy to track
+- Protects capital
+
+**Cons:**
+- Doesn't scale with wins/losses
+
+---
+
+### 2. Fixed Percentage Risk
+
+**Same % risk every trade**
+
+```
+Shares = (Account × Risk %) / (Entry - Stop)
+```
+
+**Pros:**
+- Scales with account
+- Compounds wins
+- Simple
+
+**Cons:**
+- Also compounds losses
+
+---
+
+### 3. Volatility-Based (ATR)
+
+**Position size based on volatility**
+
+```
+Risk $ / (ATR × Multiplier)
+```
+
+**Pros:**
+- Adapts to market conditions
+- Prevents whipsaw
+
+**Cons:**
+- More complex
+- Requires calculation
+
+---
+
+### 4. Kelly Criterion (Advanced)
+
+**Optimal position sizing based on edge**
+
+```
+Kelly % = (Win Rate × Avg Win - Loss Rate × Avg Loss) / Avg Win
+```
+
+**WARNING:**
+- Can be very aggressive
+- Use fractional Kelly (1/4 or 1/2)
+- Only for experienced traders
+- Requires accurate statistics
+
+---
+
+## Stop-Loss Strategies
+
+### Never Trade Without Stops
+
+**Why stops are mandatory:**
+- Limits losses
+- Removes emotion
+- Protects from disasters
+- Enables risk calculation
+
+**No exceptions. Ever.**
+
+### Stop-Loss Methods
+
+**1. Fixed Percentage**
+- X% below entry
+- Simple and clear
+- Example: 2% below entry
+
+**2. Technical Level**
+- Below support
+- Below swing low
+- Makes logical sense
+
+**3. ATR-Based**
+- 1.5-2× Average True Range
+- Adapts to volatility
+- Prevents whipsaw
+
+**4. Time Stop**
+- Exit if no progress in X days
+- Frees capital
+- Cuts losers
+
+### Stop-Loss Rules
+
+**✓ DO:**
+- Set stop BEFORE entry
+- Use actual stop orders (not mental)
+- Place stops at logical levels
+- Honor stops always
+
+**✗ NEVER:**
+- Move stop further from entry
+- Remove stop "just this once"
+- Use mental stops
+- Hope price comes back
+
+---
+
+## Position Concentration
+
+**Don't put all eggs in one basket**
+
+### Maximum Position Limits
+
+**Single position:**
+- Conservative: 10% of account
+- Moderate: 20% of account
+- Aggressive: 30% of account
+
+**Sector exposure:**
+- Maximum 30-40% in single sector
+- Diversify across sectors
+- Correlation matters
+
+**Total exposure:**
+- Day trading: 100% (close daily)
+- Swing trading: 60-80%
+- Position trading: Varies
+
+### Why Concentration Matters
+
+**Example:**
+- 50% in one position
+- Stock drops 20%
+- Account drops 10%
+- Hard to recover
+
+**Better:**
+- 10% in one position
+- Stock drops 20%
+- Account drops 2%
+- Manageable
+
+---
+
+## Correlation Risk
+
+**Avoid correlated positions**
+
+### Understanding Correlation
+
+**High correlation example:**
+- Long tech stock A
+- Long tech stock B
+- Both move together
+- Double exposure to tech risk
+
+**Better diversification:**
+- Different sectors
+- Different market caps
+- Different strategies
+- True diversification
+
+---
+
+## Leverage and Margin
+
+**Leverage amplifies BOTH gains and losses**
+
+### Margin Risk
+
+**2:1 Margin:**
+- 50% loss = margin call
+- Forced liquidation
+- Game over
+
+**Recommended:**
+- Use margin sparingly
+- Never max out margin
+- Maintain buffer
+- Understand margin requirements
+
+### Options Leverage
+
+**Options can expire worthless**
+- 100% loss possible
+- Time decay (theta)
+- Volatility risk (vega)
+- Requires different risk management
+
+**Options risk limit:**
+- Max 5-10% of account in options
+- Treat each option as high risk
+- Never bet the farm
+
+---
+
+## Risk Management Checklist
+
+**Before EVERY trade:**
+- [ ] Position size calculated
+- [ ] Risk ≤ 1% (or your limit)
+- [ ] Stop-loss identified
+- [ ] R:R ≥ 2:1 (or your minimum)
+- [ ] Within daily loss limit
+- [ ] Not overexposed to sector
+- [ ] Account for correlation
+- [ ] Emotionally prepared to take loss
+
+**If ANY unchecked → DON'T TAKE TRADE**
+
+---
+
+## Account Preservation
+
+**Capital preservation rules:**
+
+1. **Never go all-in**
+   - Keep reserves
+   - Opportunities come again
+
+2. **Accept losses quickly**
+   - Small losses are OK
+   - Don't let small become big
+
+3. **Don't average down**
+   - Adding to losers doubles risk
+   - Compounds mistakes
+
+4. **Take breaks after losses**
+   - Prevent revenge trading
+   - Clear your head
+
+5. **Reduce size in drawdown**
+   - Trade smaller when losing
+   - Build confidence back
+
+---
+
+## Common Risk Management Mistakes
+
+### ❌ Fatal Errors
+
+**1. No stop-loss**
+Result: One trade wipes account
+
+**2. Risk too much per trade**
+Result: Few losses = blown account
+
+**3. Moving stops**
+Result: Invalidates risk management
+
+**4. Revenge trading**
+Result: Emotional decisions, bigger losses
+
+**5. Averaging down**
+Result: Doubling down on mistakes
+
+**6. Over-leveraging**
+Result: Margin call, forced exit
+
+**7. Ignoring correlation**
+Result: Concentrated risk in disguise
+
+### ✓ Best Practices
+
+**1. Consistent position sizing**
+Same risk every trade
+
+**2. Hard daily loss limits**
+Stop when hit, no exceptions
+
+**3. Honest stop placement**
+Logical levels, not wishes
+
+**4. R:R minimum**
+Quality over quantity
+
+**5. Diversification**
+Don't concentrate risk
+
+**6. Regular reviews**
+Track and improve
+
+---
+
+## Risk vs Reward Balance
+
+**High Probability vs High R:R**
+
+### High Win Rate (60-70%)
+- Smaller R:R (1.5:1)
+- More trades
+- Steady equity curve
+- Example: Mean reversion
+
+### High R:R (3:1+)
+- Lower win rate (30-40%)
+- Fewer trades
+- Volatile equity curve
+- Example: Trend following
+
+**Both can be profitable if managed correctly**
+
+---
+
+## Position Sizing Examples
+
+### Example 1: Moderate Risk
+
+```
+Account: $50,000
+Risk per trade: 1% = $500
+Entry: $50
+Stop: $48
+Risk per share: $2
+
+Position: $500 / $2 = 250 shares
+Position value: $12,500 (25% of account)
+Actual risk: $500 (1% of account)
+```
+
+### Example 2: Tight Stop
+
+```
+Account: $50,000
+Risk per trade: 1% = $500
+Entry: $100
+Stop: $99
+Risk per share: $1
+
+Position: $500 / $1 = 500 shares
+Position value: $50,000 (100% of account)
+Actual risk: $500 (1% of account)
+```
+
+**Key:** Position SIZE varies, but RISK stays constant
+
+---
+
+## Emergency Procedures
+
+### When Things Go Wrong
+
+**Circuit breaker triggered:**
+1. Stop trading immediately
+2. Close positions if possible
+3. Assess damage
+4. Don't panic trade
+
+**Flash crash:**
+1. Don't chase
+2. Check your stops
+3. Wait for stability
+4. Review risk exposure
+
+**Account down big:**
+1. STOP trading
+2. Take mandatory break
+3. Full review
+4. Return with smaller size
+
+---
+
+## Risk Management Quotes
+
+**"Rule No. 1: Never lose money. Rule No. 2: Never forget rule No.1"** - Warren Buffett
+
+**"The goal of a successful trader is to make the best trades. Money is secondary."** - Alexander Elder
+
+**"Risk comes from not knowing what you're doing."** - Warren Buffett
+
+**"Don't focus on making money; focus on protecting what you have."** - Paul Tudor Jones
+
+---
+
+## Summary
+
+**Risk management is:**
+- Your edge
+- Your protection
+- Your discipline
+- Your success factor
+
+**Remember:**
+- Small consistent gains > Home runs
+- Protect capital first
+- There's always another trade
+- Survive to trade tomorrow
+
+**The math is simple:**
+- Lose 50% → Need 100% to recover
+- Lose 10% → Need 11% to recover
+
+**Trade small, trade smart, trade long-term**