Following Proper Risk Management Techniques Ensures Long Term Profitability

Risk Disclaimers; the irritating fine print we suppose to read to understand the full extent of the risk we undertake but choose not to read because the words are too small and plus who reads that drivel anyway.

I consider myself quite lucky in that regard. Although I do read through all the fine print I must admit that electing to study a risk management module in varsity is definitely paying off. First question posed to me; what is a risk?

According to BusinessDictionary.com risk is defined as:

A probability or threat of damage, injury, liability, loss, or any other negative occurrence that is caused by external or internal vulnerabilities, and that may be avoided through pre-emptive action.

Read more: http://www.businessdictionary.com/definition/risk.html#ixzz32Xf6sBJJ

The above definition is quite broad but the concept is the same when it comes to financial risk that something which may or may not be in our control can have a negative impact on the return we expect to obtain.  

When it comes to trading we know it’s a game of probabilities, if any trader tells you they have a 100% record of winning trades either his lying or his trying to sell you something. In trading there is always a chance that something might go wrong, however we can take pre-emptive action, it’s called a stop-loss, your insurance policy against rotten apples.

It’s one of those topics in trading which some are thankful that they had them in place and others regretting the larger losses they had to incur because they didn't place one.

I’ve found that one of the best ways to create consistency in your trading is to actively manage risk. There has to be a maximum threshold you are prepared to lose in any given trade. One of the well-known risk management techniques is the 2% rule. It states that the trader will not risk more than 2% of his capital in any one trade. That would suggest that you would have to lose 50 trades in a row in order to wipe out your entire capital which is close to impossible.  

This technique can be quite beneficial to the new trader as there are always going to be bumps along the way. I’ve said many times in my posts that trading is not simply funding an account and begin trading; it requires a great deal of skill and an understanding of what works. In order for a trader to do this he needs to have a set of beliefs to which he subscribes to.

 What were your first beliefs when you started trading? Most new traders are led to believe that trading is a great way to secure you a passive income without breaking a sweat. Wrong. Trading like anything else is a skill which is built throughout a process in which you have to participate in order to learn. How can you expect yourself to build a set of beliefs if you aren’t willing to invest time or money?

Beliefs are built over many trades and a lengthy period of time, which is why it is important to manage your risk effectively as possible. The above definition spoke about external and internal vulnerabilities.

Think about external forces you were unaware of when you first started trading like economic data or a war breaking out. What about internal forces like rookie mistakes, not obeying the rules or allowing your emotions to control your trades.

All these things add up and if you aren’t using the proper risk management tools then chances are you not reaching the desired goal you looking for.

Flip a coin and call head or tails. Chances are 50% of the time you’ll be right and 50% you’ll be wrong. So it’s the same in trading, two sides to a trade a buy or a sell. This would suggest that if you applied the same idea to a trade you would be able to get half your trades right.

But if you had half right and the other half wrong and gained and lost the same amount of money there would be no use to trading. However trading does allow us to gain more than what we lose if we have an edge. But how do we build an edge? By applying our beliefs to our trading process which allows us to either land more wins than losses or return a larger ratio on our winners than we have on our losers.

Going back to what I have said previously, in order for us to build our beliefs we need time and skill, these two factors allow us to build an edge over time which in the long term will make our trading a profitable entity.

I like to think of it like this; my initial capital invest is merely the school fees required to obtain my skills, the losses I incur can be put down to mistakes and my wins can be put down to doing something right. As time goes by losses begin to feel less of a mistake and more of a realism that the edge has moved out of my favour.

If I had to lose 10 trades and win 10 trades netting zero gains or losses I wouldn’t consider that a failure but merely an achievement to the amount of skill that I have built over time and as more time goes by my confidence increases to a level where I will start gaining and building my account.

Trading is about how long you can stay in the game, not how much money you can make in a single day.  Remaining prudent in my stop-losses will ensure that if I do make a mistake it won’t cost me much, my wins will cover most of my losses and at the same time open up the possibilities of beliefs that are needed to build a strong and sustainable trading plan.

In those early stages of your trading business don’t be too harsh on yourself if you haven’t gain much monetarily but rather assess your performance on how well you were able to execute your trades, obey your rules and find new beliefs that will lay the foundation to a profitable business.

If you would like to contact me you can through my email at cadetrader@gmail.com or if you wish to follow me on twitter and get the latest updates of news, interesting commentary and general trends in the market, my twitter handle is @CadeTradeR if you follow this link it’ll take you directly to my twitter timeline: https://twitter.com/CadeTradeR