Managing risk is a cornerstone of any trading plan. This guide starts with a risk management primer before diving deeper into critical topics like position-sizing and stop-loss placement.
The job of a trader is not just about profits. It is also about risk. The real job of a trader is to find the right risk to assume.
What is the right risk?
The right risk:
- Offers you, on average, a net positive return.
- Is one that you can afford to lose.
- Is the one you take for a reason, not out of your emotional whims.
Taking the right risk is difficult. This is because even the right risks cause losses in the short run. It is tough to recognize something as “right” when you lose money because of it. But if you want any chance of trading successfully, you must learn to accept losses from taking the right risk.
You need to view losses as the costs of doing business. Each trading loss is just a business expense for a profitable trading business. An expense akin to your broadband subscription fee; you cannot trade without an internet connection. Similarly, you cannot trade without losses.
A trader also faces risks beyond the financial market. There are business risks. What happens when your broker goes down? What happens if your computer fails? What happens if you lose your trading records?
The best way to deal with risk is to keep things simple. Complicated strategies, systems, and processes multiply risks.
Consistent and profitable traders have the right attitude towards risk. In a nutshell, the trader who sees himself as a risk manager wins in the long run.