Habit 5

Manage risk.
Manage the risk of ruin when you create your trading plan or system.
Manage the risk of trading when you select a market to trade. Manage the risk of unusual events.
Manage the risk of each individual trade.

The risk of ruin is a statistical concept that expresses the probability that a bad run of luck will wipe you out. On average, if you flip a coin 1,024 times, you will have ten heads in a row at least once.
Thus, if you are risking ten percent of your account on each trade, chances are you will be completely wiped out before long. If your trading method is 55 percent accurate (and whose is?), :D
you still have a 12 percent chance of being wiped out before doubling your capital if you risk 10 percent of capital per trade. For the mathematicians out there, this assumes that you win or lose the same amount on each trade. That is unrealistic, but I'm just trying to explain the risk of ruin problem.
The point is that in order to reduce the harm caused by unavoidable strings of losses, you must keep the amount you risk on each trade to about one or two percent of capital.
This makes trading with small accounts difficult. Two percent of $5,000 is only $100. That means with a $5,000, you should be trading with $100 stops. If you trade with $500 stops, your chances of avoiding meltdown from a bad series of trade are not good.
Trading with small stops is usually ineffective because they are within the market's "random noise."

Another element of risk is the market you trade. Some markets are more volatile and more risky than others. Some markets are comparatively tame. Some markets, such as currencies, have a greater chance of overnight gaps which increases risk. Some markets have lower liquidity and poorer fills which increases risk. If you have a small account, don't trade big money, wild-swinging contracts. Don't feel you have to trade any market that might make a move. Emphasize risk control over achieving big profits.

Pay attention to the risk of surprise events such as floods, currency interventions and wars. Most of the time there is some manifestation of the potential. Don't overtrade in markets where these kinds of events are possible.

The most important element of risk control is simply to keep the risk small on each trade. Always use stops. Always have your stop in the market. Never give in to fear or hope when it comes to keeping losses small. Never risk more than one or two percent of capital. Preventing large individual losses is one of the easiest things a trade can do to maximize his chance of long-term success.