February 2015

Risk management really saved me from having a truly terrible week last week.  My win-loss record was only 3 wins vs 9 losses.  One of those wins was less than 3 pips.  Without solid risk management, I could have seen myself down a boatload of pips.  However, I managed to keep it together and was down a relatively modest 19 pips for the week.  Obviously I’m not proud of going 3 for 12 and being down for the week, but I sure am glad I kept my losses under control!

After trading for a year, I’ve heard some different theories on risk management.  Some people say you have to give a trade a fair amount of room.  Trying to decide just how much room is “fair” depends on where you “know you are wrong.”  I believe this is a concept that takes screen time to fully understand.  In order to avoid taking large losses with this theory, it is critical to have sharp, well-placed entries.  If you chase a trade, it can be a long ride down to find out you were truly wrong.  We’ll talk more about this in a minute.

Another theory I’ve heard is that as soon as a trade doesn’t behave exactly as you expected it to, get out of the trade.  The problem is this isn’t our business – it’s the market makers’ business.  If we knew exactly how trades were going to behave, we’d all be batting a thousand!  However, this concept certainly has a lot of merit.  As is so often the case, it’s the subtle nuances that make all the difference.  For example, in an SMP trade, if you get a market maker dot, and you expect price to hold below that dot, if price gets above the dot, Dump The Trade!  The same idea holds true for Wealth Smart traders taking a trade up against trend break.  It’s so tempting to just want to be right and let the it play out further… only to watch the trade go further against you.  To be successful, you must not only plan a trade, but you must then trade that plan.

I have also heard a theory that you should run a large stop, sometimes as large as 30 – 50 pips.  The thought behind this is that if you see that the trade is going against you, at some point it will take a breath coming back your way and allow you to get out without as big of a loss.  This is one theory that absolutely doesn’t work for me on multiple levels.  First of all, if you run a huge stop, guess what?  PRICE CAN HIT IT!  Ask me how I know.  Nearly every time I have taken a large risk on a trade, I have hit my stop.   Additionally, when it does start breathing back in your favor, guess what?  You don’t want to get out!  You feel like the trade is finally going your way and you decision to run such a large stop is paying off.  Until 10 seconds later when price snaps hard and stops you out.  To each their own, but that style of risk management is definitely not for me.

I truly believe you have to find your own style of trading and your own style of risk management.  I like to run a tight stop.  In fact, my stop is set at just 10 pips.  On most of my trades, I will almost immediately tighten my stop up even a couple more pips.  A huge part of the reason for this is that I am absolutely useless at clicking out of a trade when it is going against me.  Whether it is pride, ego, blind optimism, or just plain stupidity, I constantly find reasons to stay in the trade.  However, if I have moved my stop to  minus 6 or 8 pips, I no longer have to worry about it.

Now, I also believe setting my stop at a place where I know I was wrong about the trade.  In order to accomplish this, I truly have to focus on my entries.  For example, I frequently want to enter close to a market maker dot (if you are a Wealth Smart trader, think about trying to get in close to trend break).  Let’s say we’re trying to go long.  The further price moves above that dot, or above trend break, the larger the negative we would have to take before knowing we were wrong.  Why?  Because we would know we were wrong when price moved below the dot or snapped short through trend break.  If we entered the trade 10 pips above the dot or trend break, there is too much risk.  If we entered 2 or 3 pips above, we have managed our risk much more efficiently.

Well, I hope this is helpful to fellow traders.  Find your own style of risk management that makes sense to you.  As for me, I need to consistently stick with my risk management principles.  But to tell you the truth, I’m sick of talking about losing.  I need to be more patient and find better trades.  Hopefully over the upcoming weeks, we can discuss when to exit trades for profit!

I always love hearing from fellow traders.  Please reach out to me at pipaddict73@gmail.com.

Happy Pip Hunting!