Six things I wish I knew when I started trading: Part One Risk Management

A famous Scottish proverb goes, “Take care of pennies and the pounds (£) will take care of themselves”.

Risk Management is something that successful traders know and starting traders wish they did know once they learn.  While a lot of beginners take on excessive risk, trying to get rich in a hurry, they are often setting themselves up for failure.   Like the flip of a coin, calling heads will always be wrong sometimes.  Here are my guidelines for risk management:

• The successful trader knows to take small amounts of risk on each individual trade.
• To never put himself in a position where he can blow up.
• To seek winners that are bigger than his losers and to have a decent winning percentage.
• Knowing that the probabilities will work in his favour.
• To add to his equity every year, as it can compound significantly over time.

While a successful trader will likely not triple his account in a short time-frame, he will always stay in the game and make significantly more over the long haul.

There will be times when gaps happen against you, and they will hurt, sometime to the tune of +20%, fortunately even with these anomalies, if you stick to your plan, even with a big shock, you can still come out the other side on top.

There is an old adage that all gamblers eventually die broke. By definition, a compulsive gambler is always looking for “action”—to bet, even if the odds are not in his favour. Unable to control his compulsion, he will keep betting and keep losing. Good trading is the polar opposite—disciplined, cautious in its approach to risk and demonstrating a clear edge. We can rescue ourselves from the gambler’s fate by vowing to “bet” only when the odds are in our favour; by risking small amounts on each trade. The results of successful risk management are profitability and wealth accumulation, worlds apart from the gambler’s fate.

Finally, I was on a course once and the lead instructor said that “you get a large account, a Rolls Royce, Lamborghini, Leer Jet, concierge life style by mitigating risk.  Mitigating risk is the key, focus on the risk and the profits will come.”  Sound advice indeed!

May today be a profitable day…for all of us!

John