a multitude of other techniques, but the first line of defense for you
will be to learn how to set effective stops and then to learn how to
adhere to those stops.
THE NEED FOR MONEY MANAGEMENT
Please understand the risks in trading the financial markets and live in full
awareness. Let your positive beliefs lead you to take the actions necessary
to succeed.
For traders to blindly enter the markets and trade simply because they
are thinking positive thoughts is to ignore the full spectrum of what is possible.
However, to live in constant fear of losing will cause you to trade the
financial markets with fear, anxiety, negativity, and aggression, which are
equally destructive.
Instead, acknowledge both sides of the coin, the good and the bad.
React to market activity with full awareness and pay close attention to
your risk control. Then you will create a positive reality with a feeling of
abundance and goodwill. By acknowledging the good and the bad—the
reality—and by fine-tuning your money management system, you are on
your way to greater prosperity.
Money management is a rather in-depth topic and I recommend that you use A
Trader’s Money Management System: How To Ensure Profit And Avoid The risk
Of Ruin (John Wiley & Sons, 2008), a book I wrote to cover this topic in depth.
It will enable you to manage your risk in every way from learning how to refine
your stops, to record keeping and analysis with The Trader’s AssistantTM, to
understanding the risk-of-ruin tables and how to determine what is the right
amount of capital to risk on each and every trade. You will probably get the
best price on Amazon.com and I urge you to continue in your quest for money
management tools since that is where you will be able to further increase your
profits.
ACCEPTING RISK
Before you can effectively accept risk in your finances, you must first completely
believe that there is a true benefit to you in doing so. This inner
belief very often comes after having experienced the power of the markets
in the form of a painful and substantial monetary loss. Regardless of how
you ultimately develop the motivation to manage your risk, it is imperative
that you do so.
There are six primary types of risk you need to accept:
1. Trade risk is the “calculated” risk you take on each trade. With ART,
your risk will never be more than 2 percent on any given trade. You will
maintain this 2 percent risk by adjusting your trade size and setting a
stop-loss exit. Advanced traders, see “Important Note” on page 78.
2. Market risk is the inherent risk of being in the market. This type of
risk involves the entire gamut of risk possible when in the markets.
Market risk can exceed trade risk. For this reason, ART traders never
actively trade more than 10 percent of their net worth. Market risk encompasses
catastrophic world events and crashes that paralyze markets.
Events causing market “gaps” in price against your trade position
is an example of market risk.
3. Margin risk involves risk where you can lose more than the dollar
amount in your margined trading account. You would then owe your
brokerage firm money if your trade goes against you.
4. Liquidity Risk. If there are no buyers when you want to sell, you will
experience the inconvenience of liquidity risk. In addition to the inconvenience,
this type of risk can be costly when the price is going straight
down to zero and you are not able to get out, much like the experience
of Enron shareholders in the year 2001.
5. Overnight Risk for day traders, presents a concern in that what can
happen overnight when the markets are closed, and can dramatically
impact the value of their position. There is the potential to have a “Gap
Open” at the opening bell, when the price is miles away from where it
closed the day before.
6. Volatility Risk can present a bumpy market that may tend to stop you
out of trades repeatedly creating significant draw down. This occurs
when your stop-loss exits are not in alignment with the market and are
not able to breathe with current price fluctuations.
Risk is inevitable in the markets and there is an art to managing the
possibilities. It is not a matter of fearing the risk; instead, focus on playing
the “what if” scenario so that you can adequately prepare yourself for any
outcome.
Read More: Managing Risk: Always Set a Stop-Loss Exit
