If you read interviews with top traders, one of the common factors no One is talking about that you will find stressed repeatedly is the idea of not losing money. In Sports lingo, you have to be able to play great defense. Whether forex trading, stock trading, or doing trades in commodity futures, the bottom line is the same.
Too many beginner and intermediate traders are more interested in playing great offense first. They are more focused on making lots of money in the markets, and not merely interested enough in keeping the money that they already have!
However, the latter is critical to your success. Although it is obvious that in Trading, you have to risk money to make money, the idea is to control that risk so that it is always strictly limited and so that you remain in control of the situation at all times. In other words, we are talking about what the investment banking industry calls Risk Management. It is just as vital for the private trader at home as it is for the major investment banks.
The reason that investment broker CMC Markets regard to risk management as essential is that without it, they would go bankrupt extremely quickly. It is at the heart of both their success and survival. Hence, if it is good enough for them, it should be good enough for you too.
Beginner traders have no idea of how to manage their risk, even as a concept. They put on a trade according to some poorly defined criteria, and when the market goes against them, they have no idea at what point to get out of the position and will let it worsen until it is simply too painful to retain.
The smart trader, however, places risk management at the heart of the entire trading plan from the very beginning. If you realize that in this game, the target is not only to make money, but also not to lose the money you’ve got, then you have made great progress before you even place your next trade.
Let’s put this a little more graphically. If you were to lose, let’s say for the sake of argument, half of your trading capital, then you have a huge uphill task ahead of you. You will have to achieve a fully 100% return, simply to break even! You will have to do even better than a 100% return actually to go into profit. Now, if you realize that very few of even the sharpest hedge funds make 100% return on capital in a year, never mind all the other more mediocre players out there, you will realize what an outlandishly monumental task this is.
If you were to ask many beginner traders, you would find that it is very easy to lose half your trading capital, or more, quite swiftly. You do this by placing too large a trading size in the first place, betting on ill-defined trading opportunities where your chances of winning are low, and then staying in the position for way too long when it is clear that it has gone against you and is not coming back anytime soon.
By contrast, the successful trader is very careful indeed about the sort of trading opportunities that are pursued and has done diligent research to identify high-probability trade setups. This trader clearly defines the risk in absolute dollar terms ahead of even initiating the trade, and places that limit as a stop loss of the position at the same time that the trade itself is placed. Hence, the trader has predefined exactly at what point in the market that the trade is a loser and has placed the exit order at the same time as the trade itself.
Another key aspect of this procedure is to limit the capital exposed to any one trade. Even following all of the above strategies would be absolutely no use if your trade size is far too large proportionate to your account size. If you enter trades where your potential loss represents one-third to one-half of your total account size, then you are almost certain to go bust within just a few trades!
By contrast, great traders ensure that their loss is not only predefined, but also small about their total account size. In this way, they ensure that they stay in the game. If a great trading opportunity comes up, but you cannot take advantage of it because you went bust, it is as good as if it had never happened. That is why you MUST play great defense, and ensure that you do your very best not to lose money.
You need to stay in the game. Remember, there will always be another trading opportunity, but only if you are still in the game