7 Risk Management Tips From Top Traders
By Galen Woods ‐ 5 min read
Risk management is a cornerstone of all successful trading plans. Learn the important aspects of trading risks from these seven top traders.
Risk management is the cornerstone of a sustainable trading plan. Yet it is always ignored by new traders who are only looking for the next fancy strategy. Furthermore, trading risks come in so many forms and can be challenging to manage even for seasoned traders.
Hence, in this article, let’s take a close look at what seven top traders have to say on risk management.
Trading quotes are well-liked because they are pieces of bite-sized advice that are easy to read. But to gain value from these timeless tips, you cannot just read and forget.
You need to act.
To help you do this, for each trading quote below, I have included action items to help you to implement them in your trading.
#1: Cutting Losses
“Letting losses run is the most serious mistake made by most investors.” – William O’Neil
Losing trades are inevitable. Always decide how to respond beforehand. Dealing with losses is not something you can handle on the fly.
- Have an exit plan when your trade goes wrong. Consider a volatility stop-loss.
#2: Sizing Your Position
“That cotton trade was almost the deal breaker for me. It was at that point that I said, ‘Mr. Stupid, why risk everything on one trade? Why not make your life a pursuit of happiness rather than pain?’” – Paul Tudor Jones
Paul Tudor Jones did not fare that badly if you look at the trading setup in isolation. It was his outsized position that ruined him. He risked too much on a single trade and lost close to 70% of the accounts he managed.
(Read more about the context surrounding this quote in Jack Schwager’s Market Wizards.)
- Establish a position sizing model and adhere to it, regardless of how confident you are in the trade.
#3: Accepting Risk
“When you genuinely accept the risks, you will be at peace with any outcome.” – Mark Douglas
Mark Douglas’ Trading In The Zone is a classic book that walks you through the mindset shifts of a successful trader. Being at peace with any outcome is critical for responding correctly to the constant market flux.
Also, think beyond the risk of losing money. To some traders, every trade they take places their ego at risk. For them, every losing trade is a dent on their self-worth. Accepting this aspect of trading as well to avoid undesirable responses to losing trades.
- After each trade, immediately ask yourself if you’re at peace. If you’re not, you have not genuinely accepted all the risks. Dig deeper to find out why. Is it because you are under-capitalized? Is it because you fail to appreciate market uncertainty? Or is it because you deviated from your plan?
#4: Preserving Your Capital
“You have to minimize your losses and try to preserve capital for those very few instances where you can make a lot in a very short period of time. What you can’t afford to do is throw away your capital on suboptimal trades.” – Richard Dennis
Richard Dennis’ words highlight the risk of missing out on good trades. The markets are generally efficient. This means that the best trades (that allow you to can make a lot in a very short period) are rare.
The cost of missing these spectacular trading opportunities is high. Hence, you need to make sure that you can take advantage of them when they present themselves. For this, you must preserve your trading capital.
- Limit losses on trades that are not working out using stop-losses.
- Consider time-based stops to ensure that your capital is not locked up in the market for no good reason.
#5: Managing Emotional Risks
“The human side of every person is the greatest enemy of the average investor or speculator.” – Jesse Livermore
Jesse Livermore recognized that traders often overestimate their abilities to handle their emotions.
I’ve experienced it firsthand. In my first few years of trading, I refused to admit that my emotions can get out of hand at times when I trade. It’s only when I faced my human side and took steps to deal with the destructive feelings that I became a more consistent trader.
- Have a plan in place to deal with flaring emotions. Don’t react blindly to fear and greed. Get some ideas here.
#6: Maintaining Perspective
“A lot of people get so enmeshed in the markets that they lose their perspective. Working longer does not necessarily equate with working smarter. In fact, sometimes it is the other way around.” – Martin Schwartz
Losing perspective is a risk to every trader. It brings about confusion.
Without perspective, you cannot trade well regardless of your trading strategy. Moreover, it is an insidious risk because a trader who has lost perspective is often unaware of it.
- Limit the hours or sessions you trade so that you focus on quality and not quantity.
- Reflect on your trading performance weekly. (Trading journals help.)
#7: Respecting Risk
“Throughout my financial career, I have continually witnessed examples of other people that I have known being ruined by a failure to respect risk. If you don’t take a hard look at risk, it will take you.” – Larry Hite
Still unconvinced of the importance of risk management? I hope the words of a Market Wizard like Larry Hite will help to convey the message.
- Take a hard look at risk. Go through your entire trading process. At every step, ask yourself: what could go wrong?
- Try your best to mitigate or manage the identified risk.
Try your best to act on the pieces of advice above, and you will be far ahead of the pack when it comes to risk management.
Nonetheless, remember that the aim is not to eliminate all risks. Trading is the art of risk-taking. The focus is to take the rewarding risks and contain the punitive ones.