Know thy risk

Posted in: Trading Article

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This is a cautionary tale of trading greedily. Although it’s just one example, the story is echoed across the trading world in one form or another.
When you see increased volatility you must know thy risk if you’re to trade profitably and avoid a blowing your account.

A slippery slope

When markets start to move a lot, it’s easy to understand why traders want to get involved. This is especially true after a period of inactivity.

But in any case, increased volatility whilst being a great provider of opportunities, also elevates levels of risk – more movement means more trading opportunities and greater chances of bigger profit targets being achieved, but it also tends to require risking a larger number of ticks in order to find out whether or not the trade will work.

Take crude oil for example.

It’s a market that’s really been moving a great amount recently and has taken a nose dive. It’s been ripe with opportunities to make some tidy profits, but if you don’t accept that the risks involved are higher than normal, it’s a very slippery slope indeed. Trading CL is never for the faint of heart, but more recently the volatility has increased considerably.

The added volatility and the fact that it has been largely directional, has contributed to people wanting to make a fast buck out of the market.Know thy risk - Crude Oil Weekly chart

 Risky business

If you normally trade CL and don’t take into account the increased volatility, trading is going to be pretty hazardous for you. It can potentially be like doubling your normal trading clip size for example, if you fail to reduce your real size.

If however, you don’t normally trade it and worse still, you normally trade a product that moves far less, the situation can be far worse. It might be like quadrupling your size if you don’t trade really small size – where one or two false moves could see weeks or months of hard graft in your core markets, wiped out in perhaps a handful of sessions or even just a few hours.

If you must trade it

If you really must trade a market when volatility increases, there are a few things that you really need to do before placing a trade.

First of all you should back-test the strategy that you intend to trade it with, just like you should normally – you have to understand whether or not the strategy is effective in the specific market you’re looking at and if there are particular times you should avoid.

You also need to know what the expected level of movement is in the market and therefore what the average risk per trade tends to be.

If you’re trading even a handful of contracts in your primary market, you can reduce the corresponding clip size you trade in the more volatile market in order to reduce risk and bring it into line with your main market.

Know thy risk

If you see a market moving aggressively and want to get involved, you can’t expect to start trading it and effortlessly make money over traders who intimately know the market. Just as there’s the opportunity to make huge profits in these sorts of conditions, there’s also the chance of taking some big losers.

So entering the market without accounting for the added risk can be very dangerous indeed. Know thy risk and stay in the game.

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Trade well.

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Coach James

James began his trading career nearly a decade ago, learning his craft in fixed income derivatives. These days, he predominantly day trades index futures using auction context as the vital ingredient to his approach. James is a firm believer in the importance of trader psychology and how it can make such a monumental difference to how well a trader performs.

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