Risk & Money Management
“Experienced traders control risk, inexperienced traders chase gains.”
~ Alan Farley
Traders win or lose is not because of their Entry method, but because of their Money Management skills.
The primary goal of trading should be stay in the game. Time is on your side. A system or method with positive expectation eventually will make you rich. This can happen only if you can continue trading.
Good traders understand that some trades will be Losers, some trades will be Winners and some will be Great Wins, but they do their best to ensure that a single trade or even a string of Losing trades will Not destroy their account balances. The only relevant point is How Much your Loss will be if you get Stopped out and what % of your account balance it represents. This is the Key.
Money management is the art of keeping your Risk of Ruin at an acceptable level while maximizing your profit potential by choosing an appropriate number of shares (the size), and by limiting the aggregate size of the position to control exposure to price shocks. Good MM helps ensure that you will continue to be able to trade through the inevitable bad periods that every trader experiences. The key to successful money management is and always has been limitation of losses.
"No other knowledge in the whole realm of trading or investing can ignite an account faster than money management."
~ Ryan Jones
You have to train yourself to trade at a smaller Size so that you trade within your Emotional capacity.
It is the SIZE of the position you put on rather than the PRICE at which you put it on that determines your ability to keep the position.
You want to limit your Size in any position so that Fear does not become the prevailing instinct guiding your Judgment. The larger the position, the greater the danger that trading decisions will be driven by FEAR rather than by JUDGMENT and EXPERIENCE. One way of knowing your position is too large is if you wake up thinking about it.
You have to trade at a Size such that if you're not exactly right in your Timing, you won't be blown out of your position.
There exists a myth that you need to trade with huge size to make significant profits. Loading up on size is called for at times when the risk/reward is in your favor, but you need to be able to handle the size. There is plenty of money to be made trading with modest size.
My approach is to build to a larger size as the market is going my way. I do the same thing getting out of positions. I start to lighten up as I see the Fundamentals or Price Action changing.
Scaling type of approach in entering and exiting positions has enabled me to stay with LT winners much longer. You have to be able to let your profits run.
POSITION SIZE is important not only in avoiding trading too large, but also in trading larger when warranted. If everything lines up in a trade, then the trade should be put on in larger than normal size.
Traders need to adjust position size in response to the changing market environment. If market VOLATILITY increases dramatically, traders need to reduce their normal exposure levels correspondingly, or else their risk will dramatically increase
The reason why so few traders produce consistent results is simply because they haven't mastered the dynamics behind what it means to keep the average loss of their losing trades much smaller than the average profits of their winning trades.
Understand and respect market realities that anything can happen at any time, great traders realize that you can never truly predict anything in the market (you can just put the odds generally in your favor over a large number of trades). They realize that it only takes one major player to come off the sidelines and change the whole picture instantly. They realize that the markets can become ‘irrational’ and that they can stay irrational far longer than we as traders can stay liquid if we let our losses get larger.
Understand probabilities and learn to think in these terms, you realize that it’s not about any given trade and whether it’s a winner or a loser. Rather, it’s about your overall edge or expectancy. So it’s about thinking in terms of a long series of trades and their overall outcome, with losing trades being a natural part of that long series of trades.
The losing trades are already factored into your strategy’s expectancy, so there’s no reason to actively avoid them. Instead, you take each trade realizing that sometimes it’ll work and sometimes it won’t, and since you can’t predict which one will or won’t, you just execute all of them with discipline and take your losses quickly with discipline knowing that this is the other way (the first being correct position sizing) to realize the expectancy of your system or strategy.
When you accept risk and losses, you realize that being ‘wrong’ is okay and just a part of a
probabilistic game, and you understand that losses don’t mean you’re a failure, and you know that you can afford losses, and you’re not overconfident about your market reads, and you don’t try to avoid losses. i.e. You overcome the obstacles to being disciplined about cutting losses and not having excessively large losers.
The practical way to be disciplined with losses is to:
Always use stop-loss orders on every single trade
Never revise your stop-loss while in a trade unless that revision decreases or keeps the