Alan Farley: Ten Ways to Manage Your Trading Risk
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Alan Farley: Ten Ways to Manage Your Trading Risk
"Ten Ways to Manage Your Trading Risk"
By Alan Farley
Special to RealMoney.com
11/11/2003 11:40 AM EST
Attention to losses is a sign of market experience. Attention to profit is a sign of market immaturity. Professional traders show a willingness to forgo marginal positions and wait for the really good ones. They also keep one eye on the downside at all times so they understand the cost of being wrong.
Newer traders focus their attention on making money, but this is a big mistake. Risk determines profitability in our modern markets. The profit chase undermines the timing that's necessary to get into the market at the most advantageous prices. This often coincides with buying when others are rushing to sell, and selling when others are running to buy.
A razor-like concentration on risk marks the boundary between a trading professional and an amateur. Of course, risk isn't nearly as sexy as throwing money at a hot stock. But we all need to examine our priorities when it comes to the trading game. Are you interested in the adrenaline rush, or do you want to survive and prosper over the long haul?
Risk management starts with the acute realization that the market is a very dangerous place. Once we recognize this fact of life, the actions we need to survive become intuitive. Here are 10 ways to approach this formidable challenge:
1.Visualize the loss. Ask yourself what you can lose on each trade before you take a position. You'll be amazed how this simple question opens the door to new opportunities you can't see when you're focused on profit. Many times a marginal pattern becomes a great trade, because there's almost no risk in jumping on board.
2.Know your pain threshold. Determine the exact dollar figure that represents the maximum loss you're willing to take on a trade. Then do the math and make sure your exposure doesn't exceed this number at any time. If it does, stand aside and wait for less risk, or reduce your position size.
3.Take free trades. Start with a small position when you're not sure what kind of risk you're taking on. Add to it after you get that small piece to move in your favor. Then concentrate on keeping the total position as a "free trade," regardless of the original pattern or setup. Great things can happen when you're in a trade in which there's no money to lose.
4.Shift your timing. Take your profit early or late, but never in between. You get your move and are looking for a big winner. Then the market stalls and threatens to reverse. Take your money right away or sit on your hands through the pullback. The worst thing you can do is to panic on the way down and sell the low, just before the position recovers.
5.Turn off the time and sales. Most traders want validation for their ideas, so they wait to see what other traders are doing before they act. This is a great way to become the bag-holder on every trade. Turn down the volume by turning off the time and sales ticker. Then focus your undivided attention on the trigger numbers where you should be in or out of the position.
6.Know your bottom line. You may think you're making money when you're not. Leave your ego at the door and compile all of your accounts into a single spreadsheet. Then see how profitable you really are. You could be patting yourself on the back for a few good daytrades while your long-term account is going to hell.
7.Develop a basket mentality. Your capacity for risk increases dramatically when you manage your positions as a group, rather than fretting over individual winners and losers. Start the day by considering how much exposure you want to take on or eliminate. Then take required action across all positions and accounts to meet this objective.
8.Settle for less. Make targets in the ideal world but trade in the real world. It's easy to destroy a good position by asking too much of it. Profit targets should be abandoned when market conditions change. It makes no sense to risk your hard-earned dollars trying to squeeze a few pennies out of a winner.
9.Listen to your inner voice. The market goes into shakeout mode three or four days a month. These are the times when price bars slice through support or resistance levels and trigger stops faster than a game of Whack-a-Mole. Use common sense to see these days coming, and then get out of the way.
10.Embrace chaos. Realize the financial markets can do anything they want to do at any time. Then realize it's just a matter of time before they actually do it. Chaos can and will come along at any moment, so practice your fire drill and have an exit plan ready to go at all times. "
(in www.realmoney.com)
By Alan Farley
Special to RealMoney.com
11/11/2003 11:40 AM EST
Attention to losses is a sign of market experience. Attention to profit is a sign of market immaturity. Professional traders show a willingness to forgo marginal positions and wait for the really good ones. They also keep one eye on the downside at all times so they understand the cost of being wrong.
Newer traders focus their attention on making money, but this is a big mistake. Risk determines profitability in our modern markets. The profit chase undermines the timing that's necessary to get into the market at the most advantageous prices. This often coincides with buying when others are rushing to sell, and selling when others are running to buy.
A razor-like concentration on risk marks the boundary between a trading professional and an amateur. Of course, risk isn't nearly as sexy as throwing money at a hot stock. But we all need to examine our priorities when it comes to the trading game. Are you interested in the adrenaline rush, or do you want to survive and prosper over the long haul?
Risk management starts with the acute realization that the market is a very dangerous place. Once we recognize this fact of life, the actions we need to survive become intuitive. Here are 10 ways to approach this formidable challenge:
1.Visualize the loss. Ask yourself what you can lose on each trade before you take a position. You'll be amazed how this simple question opens the door to new opportunities you can't see when you're focused on profit. Many times a marginal pattern becomes a great trade, because there's almost no risk in jumping on board.
2.Know your pain threshold. Determine the exact dollar figure that represents the maximum loss you're willing to take on a trade. Then do the math and make sure your exposure doesn't exceed this number at any time. If it does, stand aside and wait for less risk, or reduce your position size.
3.Take free trades. Start with a small position when you're not sure what kind of risk you're taking on. Add to it after you get that small piece to move in your favor. Then concentrate on keeping the total position as a "free trade," regardless of the original pattern or setup. Great things can happen when you're in a trade in which there's no money to lose.
4.Shift your timing. Take your profit early or late, but never in between. You get your move and are looking for a big winner. Then the market stalls and threatens to reverse. Take your money right away or sit on your hands through the pullback. The worst thing you can do is to panic on the way down and sell the low, just before the position recovers.
5.Turn off the time and sales. Most traders want validation for their ideas, so they wait to see what other traders are doing before they act. This is a great way to become the bag-holder on every trade. Turn down the volume by turning off the time and sales ticker. Then focus your undivided attention on the trigger numbers where you should be in or out of the position.
6.Know your bottom line. You may think you're making money when you're not. Leave your ego at the door and compile all of your accounts into a single spreadsheet. Then see how profitable you really are. You could be patting yourself on the back for a few good daytrades while your long-term account is going to hell.
7.Develop a basket mentality. Your capacity for risk increases dramatically when you manage your positions as a group, rather than fretting over individual winners and losers. Start the day by considering how much exposure you want to take on or eliminate. Then take required action across all positions and accounts to meet this objective.
8.Settle for less. Make targets in the ideal world but trade in the real world. It's easy to destroy a good position by asking too much of it. Profit targets should be abandoned when market conditions change. It makes no sense to risk your hard-earned dollars trying to squeeze a few pennies out of a winner.
9.Listen to your inner voice. The market goes into shakeout mode three or four days a month. These are the times when price bars slice through support or resistance levels and trigger stops faster than a game of Whack-a-Mole. Use common sense to see these days coming, and then get out of the way.
10.Embrace chaos. Realize the financial markets can do anything they want to do at any time. Then realize it's just a matter of time before they actually do it. Chaos can and will come along at any moment, so practice your fire drill and have an exit plan ready to go at all times. "
(in www.realmoney.com)
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