Let me start off by saying this, saving enough money to fund a trading account takes a great deal of time and effort. It can be even more difficult and frustrating if you have to do it twice….or three or four times! For many, this is the harsh reality of learning how to trade… TOO many people are so focused on making money that they lose sight of how they’re really supposed to be focusing on NOT losing money! Does that make sense?
It is important to note that protecting your trading account is not synonymous with never experiencing a losing trade. All traders have losing trades and losing streaks...don't kid yourself, it’s part of the deal! Loses are part of the game...It’s like I always say “professional traders are really Professional Losers”. What I mean by that is, they know when something is NOT going to work and they exit the position. They don't overthink it, or over complicate it. A trade either works or it fails and you cut the trade and move on!
I really want to hammer this point home...This is totally a repetitive statement but it's important to understand this truth...The reality is most professional traders refer to themselves as “professional losers”. As in, they know how to lose the right way. A clear example would be when a trade is showing signs that it is not going to work out they simply bail on the trade! Another example is the saying “ Cut Loses Quickly”... A seasoned trader wont sit around waiting for the trade to “come back to them”. Protecting capital entails not taking unnecessary risks (too much capital on, too large of a position, revenge trading etc) and doing everything you can to preserve your trading businesses financial resources.
Let's take things a step further...It's important to know what Risk Management is at its most basic core: “Risk management refers to the processes that are put into place when trading to help keep losses under control and keep a good risk/reward ratio. Risk management can help prevent a trader from losing all their money on the account and should be applied by both beginners and experienced traders. At the beginning of your trading career you must first consider why risk management is so important when trading and investing.”
Risk management is one of the three central pillars to trading, along with strategy and psychology. Without solid risk management, losses will start to build up. We know that it is impossible to win every trade, so it is important to keep those trades that are losers under control. This can be done using various risk management tools.
The actual textbook definition of Risk Management reads something like this:
“ In business, risk management is defined as the process of identifying, monitoring and managing potential risks in order to minimize the negative impact they may have on an organization.”
The entire idea of risk management is all about limiting negative exposure. It's about preservation of capital…”safe return of capital vs. return on capital”
Sure, if you’re going to make any money in this game you have to be aggressive and put positions on...with that said, as aggressive as you are with putting a trade on, you have to be twice as aggressive with your risk management parameters! If you don't practice solid risk management you’re destined to fail...
When it comes to managing risk on any given trade there are different ways that you can approach it. I'm not going to get into too much detail but I will give you some ideas…They are some of the more well known approaches that I was taught while attending the Securities Institute...
There is the popular idea of risking 1-3% of your account on any given trade. There is also the idea of using an asset allocation model (this is what I teach my students). There is a fixed $$$ amount, fixed share size as well as a fixed number of contracts… it all depends on the trader, their strategy and the amount of capital they’re using. The bottom line is, when you’re trading (whatever the Market of Financial Vehicle) you must make Risk Management your TOP PRIORITY!
PS: Please don’t use margin...that opens up your exposure to levels that will make you sick! Some will be saying (as they’re reading this), “but I need margin to short”. That is true...but you don't need margin to buy Put Options which gives you short exposure without using margin...again, that is a separate topic that I’ll cover in the future!
Good Luck out there and Trade Safe!!!
