Trading success can be broken down into 3 main parts, strategy, risk management, and psychology or mindset. Risk Management is a critical part of the trading plan, namely, minimize losses and maximize profits. This is where you must be disciplined and follow the rules. Big losses are the main destroyer of your account, and we can keep the risk on a trade to what is expected by setting a hard stop loss. Below is the strategy for risk management.
Risk Management for Different Opportunities
The risk on the trades is determined by the structure of the market. Depending on the opportunity, set a hard stop loss where the trade is proven to be wrong. For Elliott Wave patterns, place the stop where the count is proven to be wrong.
In this chapter I like to say that once I am in a trade I have to manage it till I am all out not sleeping on the idea that what happens, happens. So when I get in I know where my Stop Loss is and won`t move it for anything, at least till I get my first half of the position out. So in the beginning I accept the risk and move on with it. As mentioned earlier a 1:2 or 1:3 RR is a condition that has to be fulfilled for me to take that trade.
Problems Traders Face:
- Being afraid of your stop loss being hit and closing trades early is not correct. Getting stopped out at your predetermined stop loss is correct.
- If you hate being wrong and move or remove your stop-loss is not correct. Getting stopped out is correct and part of trading.
- Taking too much risk that you can’t afford to lose is not correct. Following your money management plan is correct as it should take into account how much capital you have.
Risk: Represented as R
Each trade will represent 1 Risk or 1R. The profitability of any strategy is determined by the average risk/reward ratio. This means that over a number of trades your average reward (winning trades) should be larger than your average risk (losing trades). The larger the ratio the lower your win rate can be to still remain profitable.
With a 1:2 risk/reward ratio you can be right 50% of the time and still be very profitable.
You should set up the trade in such a way that you can reach your first profit target without having to get through many obstacles. Sometimes this is unavoidable and you may want to pay attention to what the price does at major swing highs & lows and adjust stops or target if the market confirms a reversal.
Further testing could be done with targets on trades in different market conditions. For example, having larger targets in trades with the trend or in a breakout area.
Open Positions:
Only have a maximum of 3 trades open at risk at one time. If a trade reaches the first profit target it is no longer at risk. Don’t take multiple trades at the same time in different markets which include the same currency. For example EURUSD and EURJPY. If the setups are in the opposite direction then it is fine, but if they are in the same direction it is basically doubling your risk as if one moves against you then most likely both will. Market correlation is important though it can often change. Be aware of which markets are moving in similar directions (market correlation).
Drawdown: The amount your capital drops before reaching a new high watermark in your Equity Curve.
The following rules apply when you are in a larger than average drawdown. We find that by following them, we can pull out of a drawdown quicker.
- Take one trade at a time.
- Move the SL to BE when price reaches a profit equal to 1R.
Position sizing will be determined by your capital and the money management strategy you choose to follow. It is the final piece of the plan and one that will determine how quickly or slowly your capital grows or shrinks.
Trader’s Mindset: Acceptance of Risk
You must learn to accept the risk if you want to be a successful trader. Easy, I accept it! Well, it’s not that easy and is the root cause of fear and pain in trading. It is one thing to say, and a completely different thing to live it. The reason trading is so difficult for most is that you have to do what is uncomfortable. Namely, have confidence in yourself and your edge while facing uncertainty in the market day in and day out. The only way to develop those skills is through hard work. Are you ready to put in the work and commitment to change?