daytradingskills

What is Risk Management

“Rule 1: Don’t lose money. Rule 2: Don’t forget rule 1.” – Warren Buffet

"I tend to cut bad trades as soon as possible, forget them, and then move on to new opportunities. The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses. If you follow these three rules, you may have a chance." - Ed Seykota

"The whole secret to winning in the stock market is to lose the least amount possible when you're not right."  - William O'Neil

"I'm always thinking about losing money as opposed to making money. Don't focus on making money, focus on protecting what you have." – Paul Tudor Jones

"Experienced traders control risk, inexperienced traders chase gains." – Alan Farley

“Success in this game is often more dependent on the use of brakes than the accelerator pedal.”

So, the central idea revolves around avoiding or minimizing losses. A beginner trader must understand that he just can not make profit from every single trade; there are going to be losing trades. Making more money from winning trades than losing on the bad trades is the only way you gain in trading. Hence, how you limit losses in losing trades and how you protect and maximize profits of profitable trades are the only two things that decide how much you succeed in your trading business. Just as a surfer catches one wave after another, a good trader maintains the same mentality. Ride the best and leave the rest.

What is risk

Risk is exposure to the price fluctuations when you enter a trade. Traders generally view risk as the potential for the loss of capital. There is no such thing as a “risk free” trade. Hence, risk is an integral part of every trade and every trader’s life. Understanding risk is the first step towards managing it. And the only way to manage different forms of risks is by keeping them under control and try reducing or avoiding them.

Risk and your comfort level

Risk creates anxiety and anxiety affects your judgment. Not all traders can take the same amount of risk in the same situation. New traders are likely to panic rather easily when market turns against them suddenly. Hence, trying to copy the behavior and strategy of another trader can be counterproductive. One must adjust his strategies and risk level according to ones own comfort level. As you develop more insight and gain better control on your emotions with experience, you will be automatically able to perform better under riskier situations.

Trading risk

Trading risk is seen as composed of two parts: 1. the likelihood of a trade turning bad, and 2. the size of the potential loss. The former depends upon the trading system which can, of course, be fine tuned to yield somewhat better win/loss ratio. This is the glamorous side of trading which is discussed and talked about extensively everywhere. Most new traders spend disproportionately more time gaining perfection in this area.

The second part falls under risk management – from traders’ perspective, it is concerned with controlling the size of losses whenever they occur. In fact, experienced traders are more concerned about limiting losses than making money. This remains a neglected area in the beginning for a new trader until he has experienced shocking losses or seen profits turn into losses.

Risk management

Stated simply, risk management means keeping all forms of your risks under control. It may include putting stop-loss orders, taking trades only along trends, limiting trade size, hedging, trading or not trading certain days or hours, staying away from the market in some situations, controlling yourself from impulse trading, etc.

Risk management puts you in the driving seat. The more controlled your risks are, the more comfortable you feel making trades. Trading is all about grabbing opportunities as and when they arise. With your risks under control, you feel confident that you will be able to handle situations when things go wrong. Risk management stands between your survival and sudden demise. It also separates seasoned traders from the amateurs. You may have the best trading system and still fail without proper risk management.

Be aware of the biggest trading risk – impulse trading

The real reason so few succeed in trading is because the traits required for success are almost exclusively psychological. – Gary Smith

Human emotion is both the source of opportunity in trading and the greatest challenge. Master it and you will succeed. Ignore it at your peril. – Curtis Faith

The key to trading success is emotional discipline. If intelligence were the key, there would be a lot more people making money trading. – Victor Sperandeo

Risk management does not concern merely protecting your trades from the trading losses, it necessarily must device ways to protect your trades from you, the trader, as well! As long as you are unable to prevent your emotions from interfering in your trading actions, you are the biggest risk to your own trading business! Understand it in no unequivocal terms that traders lose primarily because they trade subjectively or when they convert trading into a source of emotional satisfaction.

Your only best friend here is your trading system. If you follow it with discipline, there is nothing that can take away your ultimate success.