NOT YOUR USUAL RISK MANAGEMENT ARTICLE
You can find tons of boring articles online about Risk Management in Trading. You have probably already read the golden rule: never risk more than 2% of your whole account and stuff like that. Instead of the usual clichés, let me explain how I handle losing trades, A.K.A. what “Risk Management a la ETFRX” means.
No matter how harsh this may sound, if you have ever worried about a losing trade, that was only because of one reason. Human stupidity.
If your position size is not right, you will risk too much. Take a few of these “too much risk” type of trades, and you have blown up your account. So, if you have EVER worried about ANY losing trades, then the primary reason for your worries were most definitely the sizes of your trades. Since most beginner traders think trading is a get rich quick scheme, I often hear similar stories to the following one. Someone has a £1000 account. With this small account, he opens a position which has a required margin of £500. He sets up a Take Profit and he gets amazed by how much could he make even if price would move just a little to the direction where he wanted it to move. In the meantime, he forgets to check how much would he lose if the trade would go against him. Simply because, he does not even think that could be a possibility. He knows better. The trade looks like a simple setup, “nothing can go wrong”, right?
Next thing you know: this trader has lost all his money.
If you were to do the same, then it would be more than normal that you would blow up your account as soon as the trade would go against you even by just a few percentages. As I have already explained numerous times: there is no 100% certainty in trading. If there was, then there would be no poor people on Earth. Everybody would be just trading, and everybody would be extremely rich, because trades could be predicted for 100% certainty.
The harsh reality is, trading does not work this way. There is only one thing that is 100% sure, and that is the fact that you most definitely WILL HAVE losing trades. The question is, how to deal with them? I’m not talking about how to deal with them technically because that is what I have already detailed in the Intro. I want to detail how to approach them on a psychological level.
After this lengthy introduction, let’s get STARTED!
Once you understand that you WILL HAVE losing trades, you can think about them as business expenses. See, if for example you are a cab driver, you will have to pay for fuel on a regular basis. (Unless you have a Tesla, but that is a different story.) No matter what, you won’t be able to drive your car without fuel. You WILL HAVE to spend money on it, you will have to refill your tank regularly. So what smart cab drivers can do to minimise the amount spent on fuel? Many things. They don’t run the engine while waiting long and being stationary. They don’t drive around the whole city when there is a shortcut somewhere. They go to certain petrol stations where fuel is cheaper than at other places. And so on. The main point is: they are NEVER WORRIED about this “loss of money”, as they do understand that they cannot run their business without this expense!
Stock market trading is exactly the same. If you do understand that you WILL HAVE losing trades (i.e. business expenses) and you are not someone who buys shares on a £1000 account for a £500 required margin, then you will not worry at all if the trade goes against you.
If you only risk that you don’t care about losing, you WILL NEVER be worried about ANY losing trades. Psychologically you will be in a state where you cannot even be bothered because you know well that you weren’t stupid enough to buy shares for £500 on a £1000 account. You will always understand that with a £1000 account you ought to trade only the SMALLEST positions that you can take. If your trade size is good, then psychologically your business expenses will not make you panic. Trading the smart way (i.e. the ETFRX way, haha) you will earn more than you lose, and you will have winning trades more often than losing trades. So why worry about those few, small losing trades?
So, if you:
- are checking your trades every day several times a day
- can’t sleep
- ever worried about any running positions
- can’t wait to finally close a suffering trade
- your position sizes are way too large
- and you don’t approach losing trades as naturally occurring business expenses
- Understand that losing trades are part of this business. Understand that Risk Management is not only about setting up (or not) a Stop Loss and take the right trade size. It is also about taking losing trades as naturally occurring business expenses.
- Learn to trade - do not just blindly take the trades I am signaling but also look at the charts. Over time you too should be able to find the same kind of setups that I signal. When you understand them, you will see that they are low risk, high probability trades occurring more often than losing trades. This way your “business expenses” will be kept to a minimal amount and like a smart cab driver, you will be able to drive longer without worrying about “emptying the tank”.