💰 Risk Management
Risk Management is the backbone of successful trading, but it's often overlooked by traders who want to make a quick buck.
🗣️ Common Phrases of Traders Without Risk Management
- "I thought it would work"
- "I only wanted small profits and would get out"
- "I totally did not expect this move"
- "I just need one big win and I'll make it all back"
Sound familiar? These are common phrases by traders who haven't yet grasped the true importance of risk management. They focus purely on the reward, without considering the real, present risk involved in every trade they put on.
🎯 Prioritizing Risk Management
To be a consistently profitable trader, you need to prioritize risk management and it has to be implemented into every aspect of your trading plan. This means focusing on high-probability setups, a consistent (and high) risk-reward ratio, sticking to your trading system so your trading data is useful, having a daily max loss, and knowing when to leave.
🌟 High Probability Trades
High-probability setups are a specific trade sequence that provides an exceptionally high win rate over time, with a high risk-reward factor, this should be your bread and butter. It will be different for everyone, for you it could be a strong technical level, a confluence with a certain indicator, a specific market condition, or whatever the case may be. You need to focus on these setups to increase your chance of success and reduce your exposure to random market noise. It's important to note even your highest probability setups will fail, this is why you need to control loss.
📊 Risk - Reward Ratio
You should be aiming for trades with a favorable risk-reward ratio. This simply means your potential profit is a lot larger than your potential loss, and you need to think of it as a ratio rather than a dollar amount, because as you increase/decrease your size, the ratio needs to stay the same. By aiming for a 1:2, you're risking 1 to make 2, this is important because for every one winner, it will compensate for two losers! Finding trades that are high probability and 1:2+ is not super common, which is a good thing as you become more picky and limit your risk exposure to the market and any strong move that can happen potentially against you.
📈 Sticking to System
Sticking to your trading system is another essential aspect of risk control. Many traders make the mistake of deviating away from their plan and take impulsive trades based on fear, greed, FOMO, or other emotional factors. These random trades can quickly wipe out all of your profits and make it difficult to analyze your trades. Ever take a trade, take a big loss, and ask yourself "Why in the hell did I take this trade? WTF was I thinking!", this is because it was a random, unplanned trade! Your trading needs to stay consistent, it must be clear why you're in a position, when you'd be wrong, and when you'd be right. This is the biggest challenge to people who have been trading for some time, and know when they make money but are not profitable yet. They know if they stick to their plan they can make money, but they introduce random trades that wipe out gains from their system, making them breakeven or lose traders, even though they have a profitable system!
💰 Position Sizing
This is one of the most critical components of risk management. Many traders struggle with finding the right balance between trading too small and missing out on opportunities, or trading too big and risking too much of their account. The key approach is to start off with small positions, and gradually increase your size as you build confidence and consistency within your trading system. If the opposite happens, you need to size down until you find what you're good at, and find a system you can replicate for profit, and then can gradually scale back up. It's important to note not every trade should be the same size, even if it's the same setup! You need to adjust your position size based on the volatility of the market, the strength of the overall market, confidence in the setup, and areas where you can potentially add a little bit more for a better average - all these are factors you need to take into consideration. For example, you might trade smaller during high-volatility periods or when your setup isn't as strong with a bit of a bigger stop, while you can increase your size when conditions are more favorable and all the conditions for a prime trade are met, with a stop loss as always. As a starter, I would have a baseline of normal position, and only decrease, but not increase. As you build confidence and consistency, you can scale up or add more, but as a starter, I would not. This prevents bigger losses from happening, which is key to survival.
⚠️ Stop Losses…?
This is a common mistake, and not talked about at all, but having stop loss that is incredibly tight in an attempt to minimize risk is, unfortunately, another poor risk management habit! Lots of traders will understand that yes, they need to limit risk, and go put on a 3 point stop and will get stopped out of every trade. Fast forward ten minutes and the trade is working in their predicted direction, and they either FOMO on to the next trade, or not take the trade they should because they start building doubts. While it's important you protect your capital, a stop that is too tight can actually work against you by getting you stopped out prematurely on normal market fluctuations. It's important to give your trade some room to breathe and allow for some drawdown, while still keeping risk in check. Your stop should be set before every single trade, and this is non-negotiable. Your stop should be at a place where the market will likely prove your thesis wrong, and go the other way. It should not be based on a certain dollar amount, because you do not run the market, the market doesn't care how much you lost or made! This is why finding a repeatable, and consistent strategy is important because you can scale it - from level to level. I personally risk about 10-15 points, to make 20-30+, with many occasional occurrences of hitting 60+, which lets 1 winner cover 4-6 losers. Ask yourself, if you can only take 2 trades per day, this be one of them? Remember, the more trades you put on, the more risk you're exposing yourself to. The market can do anything, at any time!
🚶♂️ Walking Away
You need to know when to call it a day, and simply walk off and leave. Even the best traders have a limited mental edge, and it's essential to recognize when your edge is no longer sharp, and simply leave. Many successful traders set a daily profit target, and a Maximum daily loss limit. A Maximum daily loss is one of the most important things to have, and it's also non-negotiable! You need to live to trade tomorrow, being out today will guarantee no future recoveries! You need to limit overtrading and giving back your gains. Similarly, if you hit your maximum daily loss limit, you need to step away and leave. This prevents the temptation of chasing losses, taking trades outside of your plan & edge. Sticking to these limits, which can change as account size grows/lessens, is there to protect your money and maintain a healthy trading mindset.
💬 Comments
- There isn't a wrong way to make money in the market. Don't listen to all the nonsense out there saying only this strategy works, or you won't be profitable otherwise. I've seen people make money consistently in the most unpredictable ways, it's the nature of the market!
- A stop is a STOP. It's there for a reason, do not change it much, and you let the market decide whether you're wrong or you're right. If you do not use stops, you WILL FAIL.
- You cannot let ONE LOSS, take you out. One loss, similarly, one win, should not make or break you. You are here for the long term, not for a five-trade gamble hoping to make it big. It's simply a numbers game, with a proper system, we know one loss can pay for the next 2-3 losses and maybe more. If you are upset about your losses, you need to re-evaluate your trading situation.
❓ Questions to Ask Yourself
- Why you're trading?
- How much you're willing to lose to figure it out?
- How do you view your losses?
This game of stocks, is NOT free. You must risk a dollar, to make anything back. No risk, no return. Pay to play, as simple as that. You will 100% take losses, you will not have a perfect win rate, and if you think any differently, you WILL FAIL. You must stick to your position sizing and max loss to stay here for tomorrow.
The day you let losses take the best of you, is the day you dig your own (trading) grave.
"The truth is that the BEST LOSER is the long-term winner."Art Simpson, Phantom of the Pits.