How Trade Risk Management Can Save You Money

Takeaways

• Think risk not profit to make money

• Why missing a trade is ok

• Change your mindset: losing money should not happen

Why is trade risk management worth it?

Because you will lose less and make more. Too many traders follow what others are doing. As a result they often join a trend which is already finishing. For example, when Tesla stock is surging upwards, they join in, just when the trend is about to change.

A trader who puts risk management at the forefront of their strategy will do the opposite. They will see the strong buying momentum, but will realise that at some point that momentum will stall and then retrace. They have realised that there is a larger risk of the share price falling than continuing its momentum upwards. As a result they will wait and then take the opposite trade.

Indeed, doing the opposite has been shown to be a successful way of trading according to one of the leading US banks.

Too volatile for me

Sometimes the best trade is none at all. If you have missed a move, it is frustrating and difficult to accept. But if you can you will have made the best trade of all. You cannot be in on every move, but you can regularly avoid stupid trades.

This also applies to individual stocks. Sometimes it is simply not worth trading a stock which is too volatile. Coinbase is an example. It can be up +20% one day, up another 10% the next before dropping -25% on the 3rd. These are huge moves, are you sure you can predict them. If you are shorting the stock, can you absorb such volatility. Indeed can you even predict where the bitcoin price will be?

If you do fancy your chances, then why not limit your position size. Why not take a fraction of your normal position size? You can still ' follow your idea' but without the frustrating loss if you get it wrong. Remember a trade you are entering now is another one you are not.

Take a risk... without taking one

Only a dummy takes a risk. A good trader makes a calculation before deciding to trade. A risk is a situation which may involve danger (losing your money). A calculation involved place the opportunity versus the risk and only going ahead if the opportunity is substantially bigger than the risk. Day traders even have a formula for this, which is called the risk reward ratio.

Serious traders only take positions in assets they understand. Although they may not perform fundamental analysis, they will know the outline to the company and what it is up to. An example if Ferrexpo.

In February 2014, when Russia invaded Crimea, Ferrexpo's shares tanked as the market reacted to their mines being in Ukraine. Willy traders who knew they were in central Ukraine (i.e. some distance from the fighting) bought into this selling. When the company informed the market of such, the share immediately recovered some of they losses.

One trader looked at the shares that day, but concluded he did not know if there was an opportunity. Sometimes the caution associated with trade risk management means you will lose out on profitable trades. Critically that trader learnt a lesson that day: increase your knowledge to be better prepared for future opportunities.

Take what you are given

A smart trader who focuses on trade risk management, will buy when the market is falling. Ideally, this is towards the end of the day and/or end of the week where professional traders are cutting down their risk.

By doing so you are giving yourself a margin of safety, something that Warren Buffet recommends.

Similarly if a position has come good and is +10% (or an equivalent positive % jump) sell it. Do not wait a few more days in the hope that it keeps going. It is best to sell early and make 10% than hope to make 20% and end up with only 6%. When momentum changes, it changes very quickly.

Diversify, diversify, diversify

Clearly not putting all your money in one stock is sensible, but what about only using one broker? Virtually every major trading or investment platform has had an outage at some point. Invariably these arrive when volatility increases - platforms software's cannot handle the increased amount of clients logging in and trading.

Typically this will happen to you when you most want to trade. If you have accounts with more than one broker, then you can place your trades with at least one broker.

If Warren Buffet does - why not you?

Too many traders are prepared to lose money. We accept that you will at some point, as after all 'the market can stay irrational longer than you can stay solvent' but why make it worse?

One of Warren buffet's core mantras is to not lose money. If you focus on that risk rather than profit, you will lose less. Making money on a trade is easy, doing is consistently is the hard part. Do not make your life harder by having to recover from poor trades.

Conclusion

Trading should be boring. It requires calculation not hunches. yes a 'feel' for the market helps, but this only comes with experience. As a beginner stay away from leverage. Too many traders quit too early because they lose too much too quickly.

Could it be that many traders accept to lose money because at bottom they do not know what they are doing? As a result traders prepare themselves for disappointment. Trading psychology is not covered enough in trading. What if you entered a trade knowing you are going to be successful...