Trading Is About Risk Management

Trading is accessible to anybody with internet, money, and a computer any time during the day.

That is one thing that lures people to trading for a living because your schedule can be what you choose.

Once they have put together a trading plan and back-tested their trading strategy, they are ready to commit real money to replace their demo account.

It is a rite of passage for them as they’ve done everything that has been suggested:

  1. They found and tested a trading strategy that meets their goals and level of understanding
  2. This strategy was tested and all trades logged so the metrics such as maximum adverse excursion can be examined
  3. They begin to follow their trading plan that includes the types of setups, stops and targets, as well as overall risk exposure for their account

Full of excitement and the discipline that something new can bring forth, they do well following the trading plan and are having success in trading.


The Trading Pothole

As traders cruise by every week following their plan, once in a while, be it fear, greed, or overconfidence, they hit a stumbling block. This “block” if not quickly dealt with, can cause everything to tumble.

Some days, people think the market will be a gift that keeps on giving. They jump back in the markets and promptly turn a winning day into a losing day.

Is it “fear” that causes this stumble? Fear of missing out? On a great day where the market just wants to pay you, those that over trade are afraid of missing that big move.

When fear of missing out (FOMO) hits you in trading, that is a warning sign that you are putting too much importance on an individual trade.

That is a huge issue because from there, traders will tweak their trading rules because of something that happened in one trade.

A trade by itself is unimportant. Trades, plural, are what really matter. Remember, wins and losses come at a random distribution.

Will your next trade win or lose?

Who knows and who cares. If you are using a method with a positive expectancy…let it play out!!

Netpicks POQ – Power Of Quitting

For day traders, we ingrain in them that power of quitting at specified times during the trading day.

We will use terms like “one and done”, or “1 trade and a positive result on the day”. The first is self explanatory and the second is simple as well:

Take one trade and if it is winner, stop trading for the day.

We will also use time stops such as only trade the first 90 minutes of the day.

For a lot of people, that takes a healthy spoonful of discipline but our statistics show following POQ can have a positive impact on your career.

If you don’t have this aspect in your trading plan, I suggest it is something you test out and implement. It can be tough but at those times, you shut down the computer and walk away.


What Hat Are You Wearing?

Trading is not a team sport and unless you are trading in a firm, you wear all the hats in the business.

  • Accountant
  • Trader
  • Researcher
  • Risk Manager
  • Tech support

They are all important but one that stands out for me the most is risk manager.

The risk manager ensures that I keep within the risk parameters and position sizing dictated by my account, the trade set up and the plan.

I answer to him and it is that role that prevents me from “jumping in”. I failed in this role back in 2008 when during a Forex swing trade,

I moved my stop loss.

I moved my stop away from price which increased my risk. It eventually lost and the initial 1.5% risk profile ended in a double digit loss. I believe, if memory serves me, it was around the 12% mark of my trading account that took a hit.


What Is Risk Management In Trading?

There are several risks in trading of course but when I say risk management and manager, I refer to these:

  • Risk manager watches trade and overall portfolio exposure
  • Ensures that stops are moved when appropriate as well as scaling out when needed

If I am in a trade that is firing with momentum and racing in my favor, the risk manager steps in and reminds me that momentum thrusts can equal mean reversion.

It ensures that I scale out and adjust risk.

The trader in me wants full position wins especially when the market is moving. The risk manager ensures I give little back and take profits when needed. I cover this in a recent post about trading sugar which is on the blog.

When I wear the hat of risk manager, I look at things only from the perspective of risk. Of protecting my capital and the profits that are appearing in a trade.

It doesn’t stop me from taking trades according to the trading plan but ensures that the risk percentage, fits the plan.


Are You Accountable?

I will say that over the years, I have done a better job of wearing the different hats.

It is hard.

Sometimes having someone to be accountable to would perhaps make things easier – but who knows trading (and yourself) better than you?

Yes, there are trading groups, trading forums, mentors, and they all can help, but if anything, I would enlist a professional in the psychological field.

Trading brings forth primal tendencies and we’ve all felt it.

  • The flush of anger when stopped out of a perfectly acceptable trade
  • The excitement of banking a 10R trade and seeing the account size grow
  • The hesitation in pulling the trigger on a legitimate trade because the last three were losers.

Believe that if trading does not work out, many people look at it as a personal failure and are scarred.

There are trading books like Trading In The Zone and anything by VanTharp that can help deal but I prefer an actual person.

But trading psychology is not the most important thing in trading.

System – Mindset – Risk

While it makes up what we call the “3 Legs of Trading”, without a sound trading strategy (I always found the Darvas Box strategy simple), it is meaningless.

If you could put it in a hierarchy, focus on getting your trading strategy and then run full steam into the psychology of trading topics.

You need a positive expectancy system first.

The mental side comes after.

The quotes about things being 80% mental often refer to the elite level, not the neophyte to something.

As you mature as a trader, you work both sides.

Author: CoachShane
Shane his trading journey in 2005, became a Netpicks customer in 2008 needing structure in his trading approach. His focus is on the technical side of trading filtering in a macro overview and credits a handful of traders that have heavily influenced his relaxed approach to trading. Shane started day trading Forex but has since transitioned to a swing/position focus in most markets including commodities and futures. This has allowed less time in front of the computer without an adverse affect on returns.