On Risk Management Or Why To Keep Your Money Always In Your Left Pocket

Profit target

On risk management- although I am not very keen on establishing a profit target level, I believe that it is still important for two reasons. First of all, if you are inexperienced trader, you can easily take profit without second guessing. Secondly, even if you are a professional trader, once you have a certain take-profit level, you can always re-evaluate how price is interacting with this level and decide whether to take your profits, partially close your position or let the trade run.

Establish a stop

It is imperative that when you are trading on the FX or any other financial market, you utilize a stop. In other words, you should decide in advance a level at which to cut your losses if price is not acting as expected. That is probably the most important factor of successful trading, because losses are twice as expensive to make up. Do not risk more than 2 percent of your initial capital per trade. In the end, everything that has been said so far can be summarized in one sentence: “cut the losses quickly and let the profits ride”. The more I trade, the more I get convinced that this is the most important trading advice one could ever give you. The simple reason that escapes a lot of traders’ minds is that if you lose 50% of your capital, you must gain 100% to get even. If you really understand the deep meaning behind those words you are already a better trader.

Take small profit, take small loss

I strongly believe that price movements are repetitive. There might be variations, but in the end, it is human emotionsthat are driving price and human nature never changes. Sometimes, I do close a position before it hits its stop loss level or take profit level. As I said earlier, although price might move in a close way to previous times, it is not absolutely identical. So, if my experience tells me that something is not going right with the FX pair (or commodity) that I am trading at the moment, I get out of position immediately. It doesn’t matter whether you are in a losing position or in a small winner. I would better get out of my position if I truly believe something is not going in the right direction. As I said- even if it is a winner, I do not keep it, but prefer to cut it on time before it is too late. The most important reason behind this action is that I am not only probably getting out of a possible loser, but I am getting more time on my side. By doing this, I have more time to analyze better the trading environment and find a better place to put my money.

Trade on evidence not expectations

Price action has shown me the importance of trading of evidence and not expectations. A lot of new traders are expecting certain price movement before it is complete. They act on a pure gut instinct and in the end they lose their capital. For me the most important thing for a trade setup is its complete form. I do not buy on expectations. If a price pattern is not complete, I simply do not take this trade.

Stick with the winner

As long as a position is revealing according to the plan, I do stick with it. If I reach my profit target and nothing goes wrong with this position- I stick with it. If price keeps on showing me that the major direction bias is still in my favor, I do not cut my position- I let it run as long as it is acting rightThat is where the money is made and that is where you want to be. The rest of the game is money management and in fact- the right money management.

Sitting and waiting

Another factor that is crucial when trading is the ability to sit and wait. You should be ready to wait for a long time before a suitable trading setup forms. You need place as many factors in your favor as possible. You should never rush into a trade. Take your time, even if you miss this one- wait for the next one. Do not overtrade, because the wise are right- pride often does come before a fall.

Risk to reward

As a general rule of a thumb a 1:2 or 1:3 is a good risk to reward ratio. With time and experience I have come to realize that 1:3 might be enough to make good profits, but sticking to winners might create winners like 1:15, 1:20 or more. Depending on my entry, I have been able to reach those numbers throughout my career and that is what professional traders are after. Even with a small winning ratio, a 1:15 return, will place all odds in your favor and you will realize how important that is.

An example from a great trader

I would like to finish with a real-life story from one of the greatest traders of all times- Jesse Livermore. One day he called his sons into the library at “Evermore”. He sat behind a massive desk, the two boys sat down in front of him. He leaned forward and took a wad of cash out of his pocket. He peeled off ten one dollar bills. He did this twice, then folded  the bills and handed each boy a pack of ten ones. Then he told them: “Boys, always carry your money folded in your left pocket. Go ahead do it. You can keep the money.” The boys did that and put the money in their left pockets. Jesse continued after that “you see pickpockets always go for a person’s wallet, usually in their back pocket. Or they come come behind you and go for your right pocket, because most people are right handed. You all right with this so far, boys?” He asked. The boys nodded and he continued. “Alright, that’s why you keep your paper money folded in your left pocket. See, if a pickpocket gets into your left pocket, and he gets close to your balls, you are going to know about it.” The boys looked at each other and their father continued: “don’t ever lose your cash boys, that’s the moral of this story. Keep it close to your balls and don’t let anyone near it.”

 

 

This material is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.